Low marginal rate taxpayers including pension funds and charities have been disappointed by the results of the $1 billion Telstra share buyback announced this week. Unlike earlier off-market buybacks, including those by the major banks BHP and RIO, the returns from participating in this latest buyback have been minimal.
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As widely predicted, the return from selling into the buyback for a zero rate taxpayer was only 3 per cent after taking into account the value of the $2.27 per share franked dividend component of the final $4.60 per share buyback price. Worse still, except for holders of 1300 shares or fewer, there was a 70 per cent scale-back of the number of shares accepted in the buyback.
In dollar terms, the buyback price including the value of the franking credits was $5.57 per share, only 17 cents per share above the Telstra share price of $5.40 when the result was announced to the market. This additional 17 cents barely compensates for the brokerage involved in buying replacement shares or for the lengthy wait until the ATO refunds in cash the value of the franking credits attached to the $2.27 dividend per share.
Even more disappointing for holders wanting to dispose of their Telstra holding, the share price traded above $5.57 for several weeks while the buyback was taking place. This is a timely warning for investors of the potential risks as well as the benefits of accepting seemingly attractive offers for their shares.
In this instance, the remaining Telstra shareholders have been the winners from the buyback of 240 million shares at a 14 per cent discount to their market price merely by using up a small percentage of franking credit reserves. The mediocre outcome for its participating shareholders will make shareholders more sceptical next time round even if the tax arrangements underwriting the buybacks don't change.
Recent developments including the sharp fall in iron ore prices and regulatory concerns about the capital adequacy of our major banks have also reduced the possibility of further large off-market buybacks by our larger companies. Put bluntly, it would be foolish for the companies affected by these developments even to consider using their large franking credit reserves to profit from buying their shares back at discounted prices.
The large resource companies will be struggling to maintain their profitability and need all their reserves to help improve their efficiency. The banks, though highly profitable, need to ensure their capital reserves allow them to continue their high dividend payouts while at the same time keeping the regulator APRA at bay and avoiding further pressure to increase their Tier 1 capital.
For these reasons, the days of generous off-market buybacks using franking credit reserves may well be over.
Daryl Dixon is the Executive Chairman of Dixon Advisory
