Lecture 5b: Payout (Share Buybacks)

Question 1

What are share buybacks

Answer 1

Companies pay cash to shareholders by repurchasing shares.

Shares repurchases are either cancelled (like in Australia) or retained as treasury stock (like in US)

Question 2

Case Study: ACORN Capital

Answer 2

9 September 2015: Announced an on-market share buyback, which suggested directors considered undervaluation of share price.

After buying back, the share price rose. Share price: NTA 70 to 85%

Question 3

What are the 3 types of share buybacks

Answer 3

1. ) Equal Access Buyback
2. ) Selective off-market Buyback
3. ) On-Market Buyback

Question 4

What is Equal Access Buyback

Answer 4

Off-market pro-rata offer to all shareholders (proportion in number of shares one own)

Question 5

What is Selective Off-Market Buyback

Answer 5

Economically similar to a reverse placement

• Buyback from specific, limited no. of investors
• Requires approval by >75% of non-selling shareholders

Question 6

What is on-market buyback

Answer 6

Repurchased shares through ordinary stock exchange trading

Question 7

What are the 6 reasons for buying back shares (ACRONYM)

Answer 7

PSAFSO

Please Stop Andy From Selling Options

Question 8

BUYBACK REASON 1: Improve performance measure (EPS)

Answer 8

Surplus Cash (i.e. free cash flows) > Repurchase > Increase EPS (Because repurchase decrease no. of stock)

However, it may:

1. ) Increase borrowing > Repurchase > Increase risk > Decrease P/E (because risk increases discount rate and decreases price)
2. ) Buyback = Less cash for reinvestment > Might lower future earnings

Impact on performance unclear

CONTROVERSIAL

Question 9

BUYBACK REASON 2: Signalling and Undervaluation

Answer 9

Typically on ON-MARKET buyback

Signalling: good
- Announcement of repurchase > New information such as likelihood of higher expected earnings in the future

Undervaluation:
- Believe shares underpriced > Managers repurchase at low price

Question 10

Any evidence supporting BUYBACK reason 2

Answer 10

Yes. Evidence that companies with share repurchase outperform over following years

Question 11

BUYBACK Reason 3: Agency Cost

Answer 11

Share buyback reduces free cash flows by returning to investors instead of wasting on unprofitable projects.

Reduce agency costs

Question 12

Any evidence supporting BUYBACK reason 3

Answer 12

Yes. Evidence that companies asset bases fall after repurchase and they reduce investment levels

Question 13

BUYBACK Reason 4: Financial Flexibility

Answer 13

Buyback/Special dividend

Share repurchase is not an implicit promise to make future repurchase
v.s.
Dividends, where the increase has to be maintained

• More flexible to buyback/special dividends than increase dividends.

Question 14

BUYBACK Reason 5: Dividend substitution/ taxes

Answer 14

Since 1980s, share buyback has increasingly replaced dividends due to taxation benefits

Question 15

BUYBACK Reason 6: Senior Management share Options

Answer 15

Senior Management: Call option (Bonus, etc)

Dividend: Prices fall on ex dividend date
vs
Share buyback: Less shares on issue, does not reduce price per share (No equivalent of an ex-dividend date)

Incentive to distribute as repurchase compared to dividend

Question 16

What makes a difference in the taxation of a share buyback. ON VS OFF

Answer 16

Depending on whether its an on/off-market buyback

ON: Standard Capital Gains Tax Provisions

OFF: Following a private ruling (how buyback will be taxed) from Australian Taxation Office, off-markets may have part of proceeds favored as a franked dividend

Question 17

What do superannuation fund holders prefer in relation to share buybacks

Answer 17

At 15%. They prefer off-market buybacks as they get franked credits

Question 18

Case: Telstra Share Buyback

Answer 18

• Announced $1bil equal-access share buyback at $4.20 per share. Share price rose that day to $4.87
• Shareholders with tax rate of 0% to 18.5% (Includes superannuation fund holders) benefited from the buyback rather than selling on the market due to franking

Question 19

What is deemed consideration

Answer 19

Australian Tax Office Determination REDUCED taxation benefits of share buybacks by calculating a deemed consideration.

• If commissioner saw capital component at $4.87, not tax benefits

Question 20

What are some survey evidences of buybacks (ON vs OFF)

Answer 20

OFF: Preferred when buyback is large to distribute franked credits (i.e. taxes; Telstra)

ON: Preferred when firms are undervalued (i.e. send signal; ACORN)

Question 21

What are some factors managers claim to factor in for share buybacks

Answer 21

1. ) Free Cash Flows
2. ) Increase Performance Measure (EPS)
3. ) Franking Credits
4. ) Signalling

Question 22

PSAFSO

Answer 22

1. ) Improved performance measure
2. ) Signalling and Undervaluation
3. ) Agency costs and good corporate governance
4. ) Financial flexibility
5. ) Dividend substitution/ Taxes
6. ) Senior Management Share Options

Question 23

What are 2 similar reasons for share buyback and dividend discussed in lectures

Answer 23

Signalling and Agency Costs

Question 24

What is the main takeaway on taxation of buybacks in the Telstra Case

Answer 24

There are huge tax benefits but it only to SOME shareholders, depend on CAPITAL GAINS TAX. LARGELY to superannuation funds.

Superannuation fund 2/3 = More capital tax loss and credit from department.