The second half of 2018 was characterised as a ‘share buyback blitz’ whereby more than $50 billion was spent by ASX listed companies to buy back their own shares. In more recent news, Commonwealth Bank, ANZ and National Australia Bank are all offering share buybacks to their shareholders, with CBA announcing they would conduct an off-market buy-back worth $6 billion. If you are a shareholder of any of these banks or would like to find out more about share buybacks and what it means for investors, continue reading.
Share buybacks occur where a company makes an offer to re-purchase some of its shares from existing shareholders which reduces the number of shareholders in the company. In theory, the effect of this is that the profit a company generates will be distributed amongst fewer investors, thus driving up shareholder returns. Henceforth, the common result of a company announcing they are buying back shares is a rise in the share price.
Why do companies decide to buy back shares?
There are a few reasons companies may choose to engage in share buybacks. The first reason as aforementioned is to increase shareholder returns. However, there are other motivations for companies to engage in this practice, including changing the company’s capital structure which has implications on their debt-to-equity ratio, as well as boosting the share price if undervalued.
What are the different kinds of buybacks?
There are two kinds of share buybacks: on market and off the market. On market occurs where a company chooses to buy back its shares on an exchange in the same way that normal shares are issued, bought, and traded. The other way for a company to buy back shares is off-market which entails a direct offering to its existing shareholders.
The latter may be offered to all ordinary shareholders, or the company may choose to be selective and therefore will only make the offer to a particular portion of its shareholders. This selective option requires a shareholder vote whereby those who are involved in the selling group are not included in the voting process. Another way in which this occurs is through an employee share buy-back scheme which involves a company making an offer to buy its shares held by current or former employees.
What are the tax implications of share buybacks?
Before making any decisions about your current holdings, it is important to consider the tax implications of share buybacks. If your shares are bought back, you will either make a capital gain or loss contingent on the price of the share when you purchased it. If you have made a capital gain this is added to your taxable income. Alternatively, a capital loss can be utilised to offset other capital gains. There may also be implications if the company pays franked dividends and if you are eligible, you may receive franking credits in addition to the money you receive from a buy-back.
What are the risks associated with share buy-backs?
As with any decision concerning your finances, it is important to weigh up the benefits, risks and costs associated with share buy-backs. There is a risk for underperforming companies to engage in share buy-backs in an attempt to raise the value of their shares and reduce the potential of the company going into administration or being acquired. This was the case for retail company, Oroton which announced a buyback scheme shortly before it went into administration and therefore left many shareholders to wear the costs of their insolvency. Hence, reinforcing the importance for investors to carry out research and obtain independent advice prior to engaging in these schemes.
If you would like further guidance around the implications of these schemes or are seeking individualised financial or investment advice, click here to organise a complimentary 20-minute phone call with an EPG Wealth adviser.