Putting a price on the Westpac buyback
As we predicted, Westpac has today announced an off-market buyback, with the size — $3.5 billion — around our expectations of $3-4 billion.
Off-market buybacks are a tax-effective mechanism for returning franking credits to shareholders who most value them.
The buyback will have a $11.34 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 Westpac on 29 October of $25.67.
As the chart below shows, using $25.67 as a guide (the actual price used for the buyback will be the volume-weighted average price of Westpac shares in the five trading days up to and including 17 December 2021), the maximum 14% discount would equate to a $22.08 buyback price.
With the capital component being $11.34, the other $10.74 would represent a fully franked dividend, which would have a $4.60 franking credit attached.
For a tax-exempt Australian investor, we estimate the buyback at a 14% discount would be worth approximately $26.68 (disregarding the time value of money), representing an after-tax profit of $1.01 or 4% compared to the market price of Westpac.
Please note that the buyback is expected to be completed on 20 December 2021, based on volume-weighted prices from the previous week.
Estimated value of Westpac buyback for tax-exempt investors
Source: Plato, Westpac buyback announcement, 1 November 2021
The value of the buyback for other investors will depend on the tax situation of each investor. At current prices, we would expect the buyback to be of marginal value for 15% tax rate Australian 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 just tax-exempt Australian investors at the maximum discount rate, we expect the final buyback price to be possibly set at below the maximum 14% discount to market price and the scale-back may be not as high as it has been for other recent buybacks.
So while we expect the buyback to not be as valuable for tax-exempt Australian investors as previous buybacks (which have often been worth 20% for every share successfully tendered), a lower scale-back will potentially increase the overall value of the buyback at the portfolio level.
We believe opportunities such as this Westpac buyback highlight why it is important that tax-exempt investors, like pension phase superannuants, have their investments managed from their tax perspective.
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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.