7 - Share Buy Backs Flashcards
Division 2 of Pt 2J of Corporations Law
1) The buy back must not materially prejudice the company’s ability to pay its creditors
2) Five categories of buy backs: equal access schemes, on-market buy backs, employee share scheme buy backs, minimum holdings buy backs, selective buy backs
3) Companies can offer to buy back up to 10% of their shares withing a 12 month period under a board resolution
On market buy backs
On market purchases at no greater than 5% above the average cost of the last sale price recorded on the ASX for each of the last 5 days.
- Advice is given to market of: value of buy back, name of broker
- Only restriction is price
Off market buy backs: Selective buy-backs
- Shares are acquired from specified shareholders at a specified price (likely to be higher than market price)
- May be a green mail repurchase of share of a corporate raider (annoying SH), to remove them from share register
Off market buy backs: Equal access buy-back schemes
- Each shareholder is invited to sell a proportion of their ordinary shares (initially at a fixed price, but Dutch Auctions are no widely used):
- SHs tender for sale of shares
- Company sets price range for auction
- End purchase price is the price which will involve the purchase of the max number of shares within the amount of funds allocated to the BB program
Off market buy backs: Employee share buy-back schemes
Two separate grounds for BBs under this provision:
1) Off-market purchase of shares from employees who have previously acquired the shares through employee share schemes (no brokerage fees)
2) Concerns over EPS dilution from employee share scheme; therefore the impact of additional shares issued to employees can be offset by purchasing a corresponding number of existing shares from the market
Off market buy backs: Dividend reinvestment buy-backs
-Intended to avoid the consequential EPS dilution effect experienced by non-participating SHs
Off market buy backs: Odd-lot buy-backs
- Purchases of shareholdings that fall below a marketable parcel that cannot be economically disposed of on market
- Marketable parcel: above $500
- Opportunity for small SHs to sell without transaction costs
- Reduces the costs of servicing large numbers of small shareholders
Income Tax and Share buy backs
- From company perspective, a buy back is tax neutral
- From SH perspective, tax implications depend on the form of BB:
- On market vs off market
Income Tax: on market purchase
- The SH is deemed to have received as consideration the purchase price for determining cap gains
- No part of the purchase price is considered a dividend
- Tax position is the same as for any sale of shares on the ASX
Income Tax: off market purchase
- Diff between purchase price paid by the company for its shares and that part of the price that is debited against the company’s share of the capital account is treated as a dividend paid out of profits derived by company on day of buy back:
- e.g., $14 BB price, $3 capital component, $11 treated as dividend (market price likely $16-17)
- The dividend is a frankable dividend: resident SHs treat the dividend in the normal way (imputation, diminish taxable income), non-resident SHs are subject to withholding tax on the amount of the dividend which is unfranked (so no incentive for foreigners for SBB)
Economic benefits of SBBs from perspective of the company
With excess CFs, the company can either (1) pay a special dividend, (2) enter into a SBB
-A special dividend equal to the BB would: distribute franking credits, have same leveraging effect. However, it would not: differentiate between SHs based on tax rates, effect EPS returns, have a signalling effect
Company perspective: key motivating theory
- From market/financial viewpoint, benefits sought by SHS are: (1) increase in leverage, increasing tax shield, (2) possible deferred tax gain due to signalling (this is only available under SBB)
- Therefore key motivating theory is signalling, which may convey management’s private information to market on an undervalued share price
Shareholder’s perspective: winners and losers from SBB
-Resident SHs with a tax rate less than 30% benefit
Economic viewpoint on SBBs
- The cost of buying the shares decreases MV of assets by an amount that exactly offsets the reduced number of shares outstanding, leading MV per share unchanged.
- E.g., if 10 shares are purchased: initial net MV of $100 with 100 shares at $1 each. After purchase, net MV of $90 with 90 shares at $1 each (same value p/share)
Accounting viewpoint on SBBs
Less shares = higher EPS
