Super funds in pension and other low rate taxpayers will be pleased by Telstra’s announcement last Thursday of an off-market buyback.
Deciding whether to accept an off-market buyback is a pretty straightforward decision. If you are paying tax at a high marginal rate (30% or higher), don’t even bother to open the offer document – throw it in the bin. If you are paying tax at 0% (such as an SMSF in pension, income under tax free threshold), you are mad if you don’t accept – and if you are somewhere in between, such as an SMSF in accumulation, it will depend on the tender discount.
What’s special about an off-market buyback?
There are two types of buybacks. An on-market buyback is conducted on behalf of the company by a broker purchasing the shares on the ASX. The other type is an off-market buyback, which is usually conducted through a tender process, and provided it is an equal access scheme, allows a company to distribute excess franking credits to its shareholders.
It is this distribution of franking credits that makes the off-market buyback very special. Part of the sale proceeds are treated as a franked dividend, with the other part treated as a capital component. Effectively, the shareholder gets a franked dividend with imputation credits, and materially reduced sale price for capital gains tax purposes. This is what makes off market buybacks so tax advantageous to some shareholders, and because shareholders are so keen to accept, means that the company can purchase the shares at a discount to the market price.
The Telstra buyback
Telstra is buying back $1bn of its ordinary shares through a tender. Shareholders will be offered the opportunity to participate and tender some, all or none of their shares. Tender documents will be dispatched by about 4 September, with the tender to close on Friday 3 October.
Shareholders will be asked to tender their shares at a discount to the then market price. The tender range is a discount of 6% and a discount of 14%. Because the buyback is only relatively small (the $1bn represents only 1.7% of Telstra’s ordinary shares), Telstra will accept tenders from those shareholders offering to sell at the lowest price (highest discount), and reject those offering to sell at a higher price (lower discount).
The buyback price will comprise two components – a capital component of $2.33, and the balance as a fully franked dividend. For example, if the market price of Telstra shares at the time the tender closes is $5.50 and the tender discount is 10%, then the buyback price will be $4.95 and comprise a capital component of $2.33 and a fully franked dividend of $2.62.
The buyback price will be the same for all tenders – so if the tender is cleared at a discount of 10%, shareholders who nominated discounts of 11%, 12%, 13%, 14% will be successful and receive the price at a 10% discount. Rather than nominate a % discount, shareholders can also nominate ‘final price’ (take whatever the market clears at). As a scale-back is expected, Telstra has also announced some priority rules – to clear successful shareholders, who are left with a residual parcel of 375 shares or less, and a guaranteed minimum allocation to successful tenders of the first 925 shares.
Should I accept?
The premise is that you should accept the buyback if your effective sale price (after tax) is higher than you could achieve by selling the same shares on the ASX. If you feel that you want to maintain your Telstra shareholding, you just buy them back on the ASX at a lower price.
Let’s then compare the two alternatives – selling your shares on market, or selling your shares in the buyback.
We will do this from the perspective of an SMSF in accumulation (paying tax at 15%), and an SMSF supporting the payment of a pension (paying tax at 0%).
We will also make a few other assumptions:
- the market price for Telstra is $5.50 (this will be determined by Telstra and announced on 6 October);
- the deemed tax value is $5.40 (this is determined by the ATO and won’t be available until October). The actual sale price for CGT purposes is derived from this by subtracting the franked dividend. It doesn’t have a huge impact on the numbers;
- purchase price for your Telstra shares – in the first 2 examples, the T1 issue price of $3.30, in examples 3 and 4, the T2 issue price of $7.40 (T3 was $3.60);
- consider a tender discount of 14% (the maximum), and also the minimum of 6%.
Four examples are shown. Example 1 uses a discount of 14%, meaning that the buyback price is $4.73. This comprises a fully franked dividend of $2.40 and a capital component of $2.33. For a fund in accumulation, the after tax proceeds from selling on market would be $5.28, or if taking part in the buyback, $5.24. Additionally, there would be a capital loss of $0.03 that could be applied against other capital gains. For a fund in pension, the buyback return is $5.76 – $0.26 higher than if the shares were sold on market.
Example 1 – Off Market Discount 14%, Shares Purchased in T1 @ $3.30, Market Price $5.50
Example 2 – Off Market Discount 6%, Shares Purchased in T1 @ $3.30, Market Price $5.50
Example 3 – Off Market Discount 14%, Shares Purchased in T2 @ $7.40, Market Price $5.50
Example 4 – Off Market Discount 6%, Shares Purchased in T2 @ $7.40, Market Price $5.50
* Value of losses can only be realised against other capital gains
In pension, it is a no-brainer to accept. At a discount of 14%, you are $0.26 better off – and at the minimum discount of 6%, you are $0.89 per share the richer.
In accumulation, it again depends on the discount – works brilliantly at a discount at 6% but not so well at a discount of 14%, so the ability to utilise the capital losses (which can only be used to offset gains on other assets) becomes important. Unless you are confident about the ability to utilize these losses, I would recommend you tender – but not at the maximum discount or final price – instead, nominate a discount that provides some return.
Finally, if you are contemplating buying some Telstra shares ahead of the buyback, they go ex-entitlement after the close of trade on Tuesday.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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