I have been a huge fan of retailer JB Hi-Fi, Australia’s best retailer. Their success means that I and other shareholders have enjoyed terrific dividends and handsome capital gains. But they are now conducting an off-market share buyback and for some shareholders, it will be an absolute “no brainer” to participate and sell their shares into the buyback.
In this article, I will crunch the numbers to show who should accept and who shouldn’t accept. And if you do accept, what are your options about re-investing the cash?
Before we get to the numbers, a re-cap on what makes ‘off-market’ share buybacks special, and how JB Hi-Fi has structured this buyback.
What’s special about an ‘off-market’ buyback?
There are two main types of buybacks. An ‘on-market’ buyback is conducted on behalf of the company by a broker purchasing the shares on the ASX. The other type is an ‘off-market’ buyback. This is conducted through a tender process and provided it is an equal access scheme, allows a company to distribute surplus franking credits to its shareholders.
It is this distribution of franking credits that make the ‘off-market’ buyback special. Part of the sale proceeds is treated as a franked dividend, with the other part treated as a capital component. Effectively, the shareholder gets a super-sized dividend with franking credits and a materially reduced sale price for capital gains tax purposes. This makes the ‘off market’ buyback tax-advantageous to some shareholders, and because they are keen to accept, means that the company can purchase the shares at a discount to the market price on the ASX.
JB Hi-Fi’s $250 million ‘off-market’ buyback
Shareholders will be offered the opportunity to participate and tender all, some or none of their shares, with the tender closing at 5.00 pm on Friday 8 April.
The tender will be at a discount to the market price, in a range from 8% up to a maximum discount of 14%. Because the buyback is capped at $250 million (which represents about 5.1% of JB Hi-Fi’s ordinary shares), JB Hi-Fi will accept tenders from those shareholders offering to sell at the lowest price (highest discount) and reject those offering to sell at a higher price (lower discount).
The buyback price comprises two components – a capital component of $3.18 and the balance as a fully franked dividend. If the market price of JB Hi-Fi shares is (for example) $50.00 and the tender discount is 14%, then the buy-back price will be $43.00. This will comprise a capital component of $3.18 and a fully franked dividend of $39.82 per share.
The buy-back price will be the same for all tenders – so if the buyback is cleared at a discount of 10% (which in this case is highly unlikely), shareholders who nominate discounts of 11%, 12%, 13%, 14% will be successful and receive the price at a 10% discount. Rather than nominate a % discount, shareholders can also tender ‘final price’ (take whatever the market clears at). As a scale-back on a pro-rata basis is likely, JB Hi-Fi has announced some priority rules – an allocation to each successful tenderer for their first 100 shares, and to clear small shareholders, residual parcels of 40 shares or less will be accepted.
The market price will be determined by calculating the volume-weighted average price of trades on the ASX over the five trading days immediately before the closing day, i.e. from 4 April to 8 April. The announcement of the buy-back price and any scale back will be made on Monday 11 April.
Should I accept?
The premise is that you should accept the buyback if your effective sale price (after tax) is higher than you could achieve by selling the same shares on the ASX. If you feel that you want to maintain your JB Hi-Fi shareholding, you just buy them back on the ASX.
Let’s compare the two alternatives – selling your shares on market at $50.00 or selling your shares in the buyback.
We will do this from the perspective of a SMSF in pension phase paying tax at 0%, a super fund in the accumulation phase paying tax at 15%, and an individual paying tax at the highest marginal tax rate of 47%.
Because we need to consider the impact of capital gains tax, we will demonstrate the outcome where the shares were purchased for $20.00, and also where the shares were purchased for $40.00.
We will also make these assumptions:
- Due to overwhelming demand, the buyback is cleared at the maximum tender discount of 14%;
- The market price is $50.00 and the buyback price is $43.00; and
- For capital gains tax purposes, the sale consideration is deemed to be $10.18. This will apply to all shareholders and is determined by the ATO after the buyback has concluded. It is essentially the market price of $50.00 less the franked dividend of $39.82 (it is a little more complicated than this, but it will be of this magnitude). JB Hi-Fi will announce the sale consideration shortly after the buyback has concluded.
Three examples are shown:
- Example 1: 0% taxpayer;
- Example 2: 15% taxpayer (assumed to be a super fund eligible for the 33.3% CGT discount);
- Example 3: 47% taxpayer (assumed to be an individual eligible for the 50% CGT discount).
In each example, there are two purchase prices: $20.00 and $40.00. Columns 2 and 3 compare the after-tax proceeds of an on-market sale at $50.00 and participation in the buyback, assuming a purchase price of $20.00; and columns 4 and 5 compare the after-tax proceeds of an on-market sale at $50.00 and participation in the buyback, assuming a purchase price of $40.00.
The after-tax proceeds is the sum of the dividend component and the capital proceeds.
In the first example, because the tax rate is 0%, the franking credits are fully refundable in cash. There is no tax to pay on any capital gain, or opportunity to apply a capital loss to offset another capital gain.
Example 1 – 0% taxpayer
In the second example, the tax rate is 15%. Effectively, half the franking credits are available as a tax refund (with no tax to pay on the dividend). On the capital side, after application of the one-third CGT discount, gains are taxed at 10% and the value of a capital loss to offset another capital gain is also 10% of the loss.
Example 2 – 15% taxpayer (assumed to be a super fund)
* Value of losses can only be accessed by applying against other capital gains
In the third example, the tax rate is 47%. There is net tax to pay on the fully franked dividend. On the capital side, after application of the 50% CGT discount, gains are taxed at 23.5% and the value of a capital loss to offset another capital gain is 23.5% of the loss.
Example 3 – 47% taxpayer
* Value of losses can only be accessed by applying against other capital gains
Conclusion
For a 0% taxpayer, such as a SMSF in pension phase or an individual who has income under the tax-free threshold of $19,200, it is an absolute “no-brainer” to accept. The effective selling price is $60.07; $10.07 higher than the market price!
Of course, to access the refundable franking credits, you will need to lodge your tax return for 21/22, so there will be a bit of a time delay to receive the full proceeds.
For a SMSF or super fund in the accumulation phase paying tax at 15%, it is moderately attractive. It is potentially worth up to $5.52 if you can utilize the capital loss to offset tax payable on other capital gains, or were planning to sell on market in any event.
If your fund is part pension/part accumulation, it will generally make sense to accept – the higher the proportion in pension, the more attractive it will be.
For those paying tax at a marginal tax rate of 34.5% or higher (the rate kicks in when your taxable income exceeds $45,000), don’t even bother to open the buyback offer document – throw it in the WPB. This ‘off-market’ buyback won’t work!
l expect that the JB Hi-Fi buyback will go the way of most other ‘off-market’ share buybacks and be heavily oversubscribed and hence subject to a scale back. The buyback discount will be 14%. As all successful tenders receive the same sale price, if you want your tender to be accepted, either tender ‘14%’or ‘final price’.
Finally, if you plan to accept, a critical decision is what to do with the money. Do you re-invest in JB Hi-Fi by buying on the ASX the shares you sell into the buyback? Do you do this before the buyback is completed (potentially taking some risk on the scale back and final market price), or do you wait till the result is announced and payment is received on 20 April? Alternatively, do you say that JB Hi-Fi is a touch expensive and re-invest those monies elsewhere or go to cash?
While I am a huge fan of JB Hi-Fi, I won’t be chasing it on market to buy back the shares I sell – my sense is that I can afford to be patient as at some stage, the market will go a little cold on retailers.
From a tax point of view, it is very clear as to who should accept and who shouldn’t. If you do plan to accept, have a plan as to what you will do with the proceeds.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.