Model portfolios: Why we’re buying Telstra

Telstra (TLS) has announced an off-market share buy-back, offering us the chance to snap up a low-risk profit.

Key Points

  • Buy-back will occur in October
  • Shareholders also entitled to 15c per share franked dividend in early August
  • Low-risk profit opportunity for each of our model portfolios 

off-market share buyback. The offer will be made to those on the register next Friday (22 August), so you need to be an existing holder or buy them before Tuesday 19 August to participate.

The key terms of the offer (as announced) are set out in Table 1. It’s important to note that, at this point, it’s just an announcement and there is a risk the offer may be changed or not proceed at all.

Table 1: Telstra buy-back announcement (key details)
Last trade date to participate 19 Aug
Tender period 8 Sep to 3 Oct
Buy-back date 6 Oct
Likely payment of proceeds 14 Oct
Payment of 15c per share franked div 26 Sep
Buy-back price? 6-14% discount to prevailing market price (determined by tender)
Capital component of buy-back price? $2.33
Franked dividend component? Buy-back price minus $2.33
Priority Allocation* 925
No scale-back if holding would be equal to or less than?* 375
* Note - Telstra have announced that they will first buy-back 925 shares from each shareholder before any scale-back of the offer. They have also said that anyone who would be left holding 375 shares or less would not be scaled back. Both these amounts are subject to change.

Off-market share buybacks are especially attractive to self-managed super funds because the cash loss made by selling shares into the buy-back is less than the franking credit attached to the dividend component. To super funds the franking credit, which is refundable, is almost as good as cash, although they have to wait until their tax return is processed to get it.

In this case, assuming the buy-back price is set at the maximum discount of 14% and the share price falls to $5.40 to reflect the 15c cash dividend due in September, shareholders taking up the offer will lose 76 cents when they sell the shares back (after collecting the dividend) but be entitled to a $1.05 franking credit (assuming they satisfy the 45 day rule). That’s 30c per share profit (see Table 2) with the potential for it to be much higher if a few things go in their favour (for instance, a rising share price or the buy-back discount being less than the 14% maximum).

Table 2: Calculation of per share profit (assuming share price falls to $5.40 after Sept div)
Purchase price (current share price) -5.55
Add: Sept franked dividend (cash) 0.15
Add: Oct buy-back proceeds (capital) 2.33
Add: Oct buy-back proceeds (dividend)* 2.31
Net cash profit/loss -0.76
Add: Franking credit (Sept div) 0.06
Add: Franking credit (Oct div) 0.99
Net after-tax profit/loss 0.30
* Note - assumes discount set at maximum of 14%. Calculated as $5.40 x 86% minus $2.33.

An important feature of the offer is the undertaking to buy-back at least 925 shares from each shareholder. Telstra also said they’ll mop up the shares of anyone who’d be left with a small shareholding (defined as 375 shares or less). So we’ll buy 1,200 shares in each portfolio, confident that we’ll be able to sell them into the buy-back, even if there’s some subsequent fiddling with the precise numbers.

Table 3 shows the possible outcomes, depending on what the share price does between now and when the buy-back price is set. Unless there’s a dramatic fall in the share price – or the buy-back doesn’t proceed in the manner expected – we’ll come out ahead. It should be enough of a profit (with the chance of a windfall) to make it worth spending a few minutes buying the shares and then signing the buy-back documents when they arrive.

  Telstra share price when buy-back price is set
Table 3: Examples of potential outcomes for each model portfolio*
  5.00 5.20 5.40 5.60 5.80
Purchase price (current share price) -5.55 -5.55 -5.55 -5.55 -5.55
Add: Sept franked dividend (cash) 0.15 0.15 0.15 0.15 0.15
Add: Oct buy-back proceeds (capital) 2.33 2.33 2.33 2.33 2.33
Add: Oct buy-back proceeds (dividend)* 1.97 2.14 2.31 2.49 2.66
Net cash profit/loss per share -1.10 -0.93 -0.76 -0.58 -0.41
Add: Franking credit (Sept div) 0.06 0.06 0.06 0.06 0.06
Add: Franking credit (Oct div) 0.84 0.92 0.99 1.07 1.14
Net after-tax profit/loss per share -0.19 0.05 0.30 0.55 0.79
Total after-tax profit/loss -229.71 65.14 360.00 654.86 949.71
Notes:          
1. Based on each model portfolio buying 1,200 shares at $5.55 (purchase will be done at today's closing price).
2. Calculations assume all shares bought back and no change to offer as announced.  
3. Assumed that discount is set at 14% (maximum).      

 

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