Earnings Season – Buyback Bonanza!

Corporate Skyline

A bumper earnings season has seen many major portfolio stalwarts such as Telstra, Woolworths and the major banks announce share buyback schemes.

Some of these are on-market, meaning there is no decision making required by shareholders. Others are off-market (such as Woolworths and CBA) which involve the holder making a decision about their participation. Often reams of confusing paperwork are sent to shareholders offering an opportunity to be involved.

A share buyback is a good use of excess cash for a company. It allows them to reduce their shareholder base while distributing the cash in a tax effective way to the shareholders. Typically, the shares are bought back at a discount (usually 10-14%) from the prevailing share price. It raises the obvious question – why would you accept this if you could sell these shares at a discount when you could sell them on-market at the current market price?

The answer is typically for tax reasons. The proceeds you are paid in a buyback are often made up of different components than if you just sold the shares. The proceeds can be part-fully-franked dividend, part-capital. If the part-capital is quite small, it may significantly reduce any capital gain implications. Perhaps even enough to offset the buyback discount making it a more profitable transaction.

For example, the current Woolworths Buyback price is made up of two components. The first, $4.31 per share, is the capital component. This is the price compared to your purchase price for calculations of capital gains tax. Given the share price for Woolworths is currently over $40, which for many is a significant gain on the price they paid for the shares, this potentially turns a large capital gain into a capital loss, thus reducing or eliminating Capital Gains Tax.

The difference between the buyback price (remember it will be at a 10-14% discount to the current price) and the capital return ($4.31 per share) will be a dividend, possibly fully franked. A one-off larger dividend due to buyback participation also needs to be considered in your tax planning.

Should I participate in the buybacks?

Our general rule with buybacks is that if you don’t need the cash and you remain a long term investor, we typically don’t participate. Again though, every circumstance is different and a simple answer often can’t be given. Contact us today, we are always happy to discuss what is a complex subject with you.

This website contains general advice which does not consider your particular circumstances. You should seek advice from Wakefield Partners who can consider if the general advice is right for you.