McMillan Shakespeare writes a buyback into its script
McMillan Shakespeare (ASX: MMS) has today announced an $86m off-market buyback along with some strong results with FY22 normalised NPAT increasing 16.5% from FY21.
Off-market buybacks are a tax effective mechanism for returning franking credits to shareholders who most value them.
The buyback will have a $0.99 capital component, with the balance being a fully franked dividend. It will be based on a tender, with investors tendering to sell shares at a discount of between 10% to 14% below market price. Shareholders who don’t participate will still benefit from the buyback, to the extent that shares are effectively bought back at a cash discount to market price. This compares with on-market buybacks, where companies buy-back stock at market price.
We have analysed the value of the buyback for tax-exempt investors such as charities, foundations, pension phase superannuation and individuals below the income tax threshold using the market price of McMillan Shakespeare on August 29 of $13.98 – see Chart 1 below.
Using $13.98 as a guide (the actual price used for the buy-back will be the volume weighted average price of McMillan Shakespeare shares in the five trading days up to and including October 21, 2022) the maximum 14% discount would equate to a $12.02 buy-back price. With the capital component being $0.99, the other $11.03 would represent a fully franked dividend, which would have a $4.73 franking credit attached.
For a tax-exempt Australian investor, we estimate the buy-back at a 14% discount would be worth approximately $16.75 (disregarding the time value of money), representing an after-tax profit of $2.77 or 20% compared to the market price of McMillan Shakespeare on Monday. Please note that the buy-back is expected to be completed on October 24, 2022, based on volume weighted prices from the previous week.
Chart 1. Estimated value of the McMillan Shakespeare buy- back for tax exempt investors.
The value of the buyback for other investors will depend on the tax situation of each investor.
We would expect the buyback to be of some value for 15% tax rate Australian investors, but significantly less that the 20% number for tax-exempt investors. The precise value will be determined by investor circumstances, the deemed capital value that the ATO will issue after the close of the buyback and the final buyback price relative to the closing market price.
Given that we estimate the buyback is valuable for both tax-exempt and 15% tax rate Australian investors at the maximum discount rate, and given the moderate size of the buyback relative to McMillan Shakespeare’s current market capitalisation (approximately 10%), we would expect the final buyback price to be set at the maximum 14% discount to market price.
We would also expect, based on similar buy-backs, that the buyback will be oversubscribed and thus investors would be likely subject to potentially large scale-back – that is only a small portion of shares tendered would be successfully bought back in the buyback.
So whilst we expect the buy-back to be quite valuable for tax-exempt Australian investors for every share successfully tendered, any scale-back will reduce the overall value of the buyback at the portfolio level.
Plato expects to tender all McMillan Shakespeare shares owned by the Plato Australian Shares Income Fund into the buyback as this fund is managed from the perspective of tax-exempt Australian investors. This means that investors in both the Plato Australian Shares Income Fund and Plato Income Maximiser Limited (ASX: PL8) should benefit from the McMillan Shakespeare buy-back. We believe opportunities such as this McMillan Shakespeare buy-back highlight the importance of tax-exempt investors like pension phase superannuants having their investments managed from their tax perspective.
Please note that this analysis depends very much on the particular tax status of the investor. We would suggest individual investors should seek professional tax advice based on their individual tax circumstances.
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Peter is a Senior Portfolio Manager and manages the Plato Australian Shares Income Fund. He is a founder of Plato and has 15 years investment experience. Peter received 1st Class Honours and a PhD from UNSW.