On Thursday 1 November 2018, BHP announced that it plans to return USD 10.4 billion to its shareholders through the combination of a USD 5.2 billion off-market buy-back (Buy-Back) of BHP Billiton Limited shares (Shares), and a proposed USD 5.2 billion special dividend (Special Dividend), which BHP intends to pay after the completion of the Buy-Back. This shareholder return program will deliver on BHP’s commitment to return to shareholders the net proceeds from the sale of its Onshore US assets in a timely manner and will generate value for all BHP shareholders.
The off-market Buy-Back is usually conducted through a tender process and, provided it is an equal access scheme, enables a company to distribute surplus franking credits to its shareholders. Part of the sale proceeds is treated as a franked dividend, with the other part treated as return of capital. Shareholders effectively receive a franked dividend with imputation credits and a substantially reduced sale price for capital gains tax purposes (capital component).
The final Buy-Back price will be determined based on the five-day volume weighted average price up to the closing date of the offer, on the 14th of December 2018. Participation in the offer is optional and BHP Limited shareholders will be asked to tender their shares at discounts of 10% to 14% (in 1% increments) to the market price, or at the final price tender. The Buy-Back will take place at the largest discount which enables USD 5.2 billion to be applied to the Buy-Back with shareholders having the option to set the minimum price below which the shares will not be bought. All shares tendered offered at the final price or at or greater than the discount chosen by BHP will have their shares bought back. While successful tenders may be subject to scale-back, in the event of scale-back there will be a priority allocation for the first 165 shares which will be accepted in the Buy-Back. If the resulting shareholding is small, 65 shares or less, and all shares are tendered, there will be no scale-back.
The buyback will comprise two components – a capital component of AUD 0.38 and the balance as a fully franked dividend. If the market price of BHP shares is (for example) AUD 32.21 (current price at the time of writing this) and the tender discount is 14%, then the buy-back price will be AUD 27.70 per share (AUD 32.21 X 0.86). This will comprise a capital component of AUD 0.38 and a fully franked dividend of AUD 27.32 (AUD 27.70 – AUD 0.38). As discussed above the Buy-Back price will be the same for all tenders and given the attractiveness of the Buy-Back to those on low or zero tax rates, we expect the discount to the prevailing market price to be the maximum 14%. In addition, the Buy-Back is likely to be significantly oversubscribed, as has generally been the case with prior buybacks from BHP and Rio Tinto. Shares tendered in BHP’s 2011 off-market USD 6.3 billion Buy-Back were subject to scale back of 78.3% after the priority allocation and small holding repurchases.
Using our example of a shareholder within the tax-free threshold, or a superannuation fund in pension phase, the proceeds of the dividend, franking and capital return by participating in the Buy-Back would total AUD 39.41 per share, or 22.40% more than the assumed market price of AUD 32.21. This assumes a Buy-Back price of AUD 27.70 (AUD 32.21 X 86%) after the 14% tender discount composed of a capital return of AUD 0.38, a dividend of AUD 27.32 (Buy-Back price less capital return) and an attached franking credit of AUD AUD 11.71 [((1/0.7)-1) X 27.32]. In this case, total receipts would be AUD 39.41 (0.38 + 27.32 + 11.71) versus a possible AUD 32.21 per share for an on-market sale.
Taking the example of a super fund taxed at 15% at accumulation phase, a Buy-Back price of AUD 32.21 would result in after-tax receipts of AUD 33.56 per share – AUD 0.38 of capital, AUD 27.32 of dividend and AUD 5.85 of franking credits, after the 15% tax (AUD 11.71 franking credit X (15%/30%) = AUD 5.85). This would exceed the proceeds from an on-market sale by 5.7% based on after tax proceeds of AUD 31.73. This is based on an illustrative cost base of AUD 27.44 per share which is a simple five year average of the closing price, and that the shares have been held for at least a year to qualify for the one-third discount on capital gains. The mathematics to arrive at the proceeds from the on market sale is: (32.21 – (32.21 – 27.44) X (1 – 0.33) X 15%) = AUD 31.73. This calculation will change depending on the cost base and so the potential taxation implications of selling on-market vs selling into the Buy-Back.
In addition, depending on the cost base of the shares sold, shareholders could generate and crystallise further capital losses by participating in the Buy-Back. This may be a useful offset against other realised capital gains, such as in a superannuation fund, or to be carried forward to offset against future capital gains and potentially reduce the taxation payable at that stage. For example, if we assume a tax value of AUD 32.21, a Buy-Back price of AUD 27.70 and an illustrative cost base of AUD 27.44 per share, a super fund would generate a capital loss tax credit of AUD 2.26 per share by participating in the off-market Buy-Back. Adding this potential capital loss tax value to the AUD 33.56 of cash income would result in total after-tax Buy-Back proceeds of AUD 35.81 per share, or 12.8% greater than the AUD 31.73 per share after-tax return from selling on-market.
In the above example, the nominal capital loss on disposal is AUD 22.55 per share (cost base – capital return – (tax value – Buy-Back price), or (27.44 – 0.38 – (32.21 -27.70). This then becomes AUD 15.03 post the 33% super fund capital gains discount – assuming shares were held for at least a year – and translates to a potential capital loss tax credit of AUD 2.26 per share at the 15% tax rate. (22.55 X 2/3 = 15.03 X 15% = 2.26).