Analysis of woolworths’ share buyback

Detailed analysis of buyback

Following the recent sale of its petrol business, Woolworths has announced the return of $1.7bn to shareholders via an off-market share buyback.

Woolworths decision to offer an off-market share buyback will be welcomed by self-managed superannuation funds (SMSF). Due to the high franked dividend component, this seems appealing from a tax point of view for low rate or zero rate taxpayers to accept.

Deciding whether to accept an off-market share buyback is a pretty straight forward decision. If you are paying tax at a high marginal rate (34.5% or higher), then it generally doesn’t make sense. If you are paying tax at 0% (such as an SMSF in pension or an individual with income under the tax-free threshold), it generally is a good deal. If you are somewhere in between, such as an SMSF in accumulation, then depending on the tender discount and your ability to use any capital gains tax loss, it will generally make sense to accept.

Of course, if you sell some or all of your Woolworths shares in the buyback, you will need to decide what to do with the cash.

Shareholders who participated in the recent BHP and Rio off-market share buybacks and who didn’t replace the shares on market might be ruing their decision given the recent surge in these companies share prices, so it is important to have a strategy in mind when deciding whether to participate or not.

In regard to Woolworths, the major brokers view Woolworths as being fully priced. According to FN Arena, the consensus target price is $28.75, a discount to the current market price. The range of targets is a low of $26.00 to a high of $31.00. There is one buy recommendation, five neutral recommendations, and two sell recommendations.

What’s special about an off-market buyback?

There are two types of share 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 share buyback which is usually conducted through a tender process, and provided it is an equal access scheme, allows a company to distribute surplus 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 is treated as a franked dividend, with the other part treated as a capital component. Effectively, the shareholder gets a franked dividend with franking credits, and materially reduced sale price for capital gains tax purposes. This is what makes off market buybacks so advantageous to some shareholders, and because shareholders are keen to accept, the company can purchase the shares at a discount to the market price.

Woolworths off-market share buyback

Shareholders will be offered the opportunity to participate and tender all, some or none of their shares, with the tender closing at 7.00pm (AEDT) on Friday 24 May.

The tender will be at a discount to the market price, ranging from 10% up to a discount of 14%. Because the buyback is capped (the $1.7bn represents about 5% of the issued capital of Woolworths), it 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 will comprise two components – a capital component of $4.79 and the balance as a fully franked dividend. If the market price of Woolworths shares is (for example) $30.00 and the tender discount is 14%, then the buy-back price will be $25.80. This will comprise a capital component of $4.79 and a fully franked dividend of $21.01.

The buy-back price will be the same for all tenders – so if the tender is cleared at a discount of 12%, shareholders who nominate discounts of 12%, 13% and 14% will be successful and receive the price at a 12% discount. Rather than nominate a % discount, shareholders can also tender ‘final price’ (take whatever the market clears at). As a scale-back is probable, Woolworths has announced a priority allocation of up to 180 shares per shareholder. No scaleback will be applied to the first 180 shares (provided the tender meets the discount/final price requirement).

The market price will be determined by calculating the volume weighted average price of trades on the ASX over the 5 trading days immediately before the closing day, i.e. from 20 May to 24 May. The announcement of the buy-back price and any scale back will be made on Monday 27 May, with payment to successful tenders on Thursday 30 May.

Shareholders worried about Woolworths share price during the buy-back period can also set an overall minimum price. If your tender discount is successful (this also includes ‘final price’ offers), you will only be accepted if the buy-back price is equal to or above your minimum price.

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.

Let’s compare the two alternatives – selling your shares on market at $30.00, or selling your shares in the buyback.

We will do this from the perspective of an SMSF in accumulation (paying tax at 15%), and a SMSF supporting the payment of a pension (paying tax at 0%).

We will also make a few other assumptions:

• For the off-market buy-back, the deemed tax value is also $30.00 (this is determined by the ATO and won’t be available until after the buyback is completed). The sale price for CGT purposes is the deemed tax value less the buyback price, plus the capital component. In the examples below, this is $7.79 if the tender discount is 10%, or $8.99 if the discount is 14%;
• Purchase price for your Woolworths shares - in the first 2 examples, $20.00, and in examples 3 and 4, $35.00;
• A tender discount of 14% (the maximum), and also the minimum of 10%.

Four examples are shown:

• Example 1: discount of 14%; original purchase price of $20.00;
• Example 2: discount of 10%; original purchase price of $20.00;
• Example 3: discount of 14%; original purchase price of $35.00;
• Example 4: discount of 10%; original purchase price of $35.00.

In Example 1, the market price is $30.00. Applying a 14% discount, the buy-back price is $25.80, which comprises a capital component of $4.79 and a fully franked dividend of $21.01.

For a fund in accumulation paying tax at 15% (columns 2 and 3), the after-tax proceeds from selling the share on market would be $29.00. If the shares had been sold via the buy-back, the effective after-tax price is $30.30. There is also a capital loss of $11.01, which is potentially worth another $1.10 (15% tax rate, one-third discount) if it can be applied to offset a capital gain on another asset. This takes the potential effective selling price to $31.40.

For a fund in pension (columns 4 and 5), the buy-back return is $34.80 per share, $4.80 higher than if the shares were sold on market.

Example 1 – Discount 14%, Original Purchase Price of $20.00, Market Price $30.00

*Value of losses can only be accessed by applying against other capital gains

Example 2 – Discount 10%, Original Purchase Price of $20.00, Market Price $30.00

* Value of losses can only be accessed by applying against other capital gains

Example 3 – Discount 14%, Original Purchase Price of $35.00, Market Price $30.00

* Value of losses can only be accessed by applying against other capital gains

Example 4 – Discount 10%, Shares Purchased at $35.00, Market Price $30.00

* Value of losses can only be realised against other capital gains

Conclusion

In pension, it is a no-brainer (from a tax point of view) to accept. At a discount of 14%, you are $4.80 per share better off – and at the minimum discount of 10%, you would be $6.52 per share richer!

In accumulation, it will largely make sense to accept, morseo if you can utilize the capital loss (that is, offset it against a capital gain).

Offmarket share buy backs have historically proved to be very popular. Although this is a little larger than the norm, representing 5.0% of Woolworths ordinary shares, the franked dividend component is high. It is likely to be oversubscribed and a scaleback should be expected. As all successful tenders receive the same sale proceeds, if you want your tender to be accepted, either tender ‘14%’or ‘final price’.

And if you want to review the outcome for a high marginal individual taxpayer paying tax at 47% (45% plus 2% Medicare Levy), see Example 5 below. Even at the most favourable tender discount of 10%, a shareholder, after taking into account the value of the capital gains tax loss, is $3.18 per share worse off.

Example 5 – 47% taxpayer, Discount 10%, Market Price $34.00, Purchased at $20.00 or $35.00

* Value of losses can only be realised against other capital gains