Very shortly, nearly one million shareholders will have to decide whether to participate in the off-market buy-back of $1 billion of Telstra shares. The good news is, ignoring this offer is unlikely to result in any significant loss for several reasons.
The first and most important reason is that, apart from small holders of 1300 or fewer shares, the number of shares accepted in the buy-back is likely to be scaled back. This is because the company's nearly $70 billion capitalisation is huge compared with the $1billion allocated to the buy-back. Even when the holdings of
non-residents not eligible to participate in the buy-back are allowed for, Telstra is buying back only a small percentage of the shares eligible to be offered for sale.
The second reason is that most eligible shareholders would obtain more from selling their shares on the market than from participating in the buy-back. The relatively small size of the buy-back is likely to result in the price being set at the maximum 14 per cent discount to the Telstra share price over a specified five-day trading period. That price will be set after the shares trade ex-dividend on current indications in a range between $5.40 and $5.50 a share. At these ex-dividend share prices, the buy-back price is likely to be in the $4.64 to $4.73 range.
Clearly, selling on the market is a more attractive option unless there are capital gains and/or income tax advantages emanating from the special tax arrangements applying to the buy-back. The first $2.33 a share will be a return of capital and the balance of, for example between $2.31 and $2.40 a share as a franked dividend. With the company tax rate of 30 per cent, the pre-tax value of this dividend will be between $3.30 and $3.43 a share. The combined value of these two components before allowing for capital gains and income tax is between $5.63 and $5.76 a share.
These are higher amounts than the proceeds of selling the shares on market but only if there's not significant capital gains or income tax payable on the proceeds. This means that participating in the buy-backs is likely to be attractive only to charities, pension funds and low income individuals not subject to income tax or capital gains tax. Even then, additional proceeds from accepting the buy-back will be less than 5 per cent.
Unless there is a need to sell some Telstra shares to meet cash needs or rebalance portfolios, the short-term profit even for those shareholders participating in the buy-back could easily disappear if the Telstra share price rises. Even at today's higher share prices, the ongoing dividend yield is still above 5 per cent p.a. fully franked, equivalent to an interest rate of more than 7 per cent.
In summary, the buy-back is likely to be attractive only for shareholders paying little or no tax and then only if they want to reduce their holdings anyway. Unlike many previous buy-back offers, the potential returns from accepting this buy-back and then buying replacement shares offers the potential of a small return.