By Leon de Wet

Why would a company that’s issued shares to raise capital, later decide that they want to buy some of those shares back? Well, there are a few reasons why they might decide to take this action.

Some companies feel that their shares are undervalued. This might happen when investors are focused on a short-term issue. In this situation a buyback is the company investing in itself and the bright future it sees a year or two ahead.

Another reason may be that a company has more capital than it needs to fund future growth. By returning capital to shareholders, companies can boost financial metrics such as earnings per share (EPS) because there are fewer shares on issue. All things being equal, a higher EPS in turn lowers a company’s price-earnings ratio (P/E).

A buyback can be done via:

  • on-market buybacks where a company buys its shares on a stock exchange with the proceeds generally capital gains or losses.
  • off-market buybacks when the company makes its offer directly to shareholders to tender shares for purchase, typically at a discount. They also comprise of a capital and, usually, large dividend component.

A major problem with off-market buybacks is that, while all shareholders can participate, it only makes sense for some because the buyback price is usually at the maximum discount to the market price designated by the ATO – i.e. 14% of the volume weighted average price (VWAP) prior to the buyback announcement.

The benefits of the buyback lie firstly in the franking credits attached to the franked dividend portion of the buyback price, and secondly, the capital loss due to the capital portion of the buy back price being only a fraction of the market share price.

Since those on higher marginal tax rates must pay ‘top-up’ tax on dividends, it is usually only those in the zero or 15% tax brackets like super funds, retirees and charities that really benefit due to the imputation rebate received.

There is also a lot of uncertainty around how successful tenders will be for shareholders, because large scale buybacks are common, meaning shareholders only have some of their shares bought back.

To conclude, depending on your tax situation, selling shares via an off-market buyback may result in a higher after-tax return than selling

If you would like more information please call 1300 ELSTON or contact us.