Rio Tinto off-market buyback

Rio Tinto (RIO.ASX) announced a buy-back loaded with a significant amount of franking credits.

The key question; is it worth it?

RIO have offered buy-backs before, and sometimes they work out very well.

For those of you who remember, the last time BHP traded up at $50 a share (pre-S32 adjustments) in 2011, it was off the back of BHP announcing a lucrative buy-back. This buy-back gave some astute investors 24%+ returns in less than six (6) weeks’ time.

RIO’s recently announced buy back could be a similar opportunity – but as we all know; the devil is in the detail – and that detail is what we’ll unpack right now.

RIO’s announcement is available here.

What is a buy-back?

RIO offer to buy your shares directly from you. There is no broker and no brokerage to pay because the whole transaction is performed off-market. Hence the full name ‘Off-Market Buy-Back’ (OMBB).

What is this buy-back (OMBB) so interesting?

Two reasons:

1. Franking credits

2. Capital losses

The OMBB is offering approximately $25.46 in franking credits per share. That’s a lot more than the $0.73 in franking we got from the RIO dividend just a few months ago in August this year (being RIO’s largest interim dividend ever).

So, for those investors who value franking credits, it’s time to pay attention (calculations explained below).

Capital losses are appealing to some investors for offsetting capital gains. This can be a tricky situation, so make sure you check it over with your accountant first or get the appropriate tax advice.

This article is not tax advice, and while we’re talking about disclaimers, this article is not personal advice either.

Here is CPA Australia’s search function if you need to find a registered accountant.

How many franking credits are on offer?

The franking credits are where the devil is in the detail.

This offer has three main moving parts to the buy-back. The variables are:

1. The current share price

2. The final price when the offer closes

3. The discount to the final price

The variables to use:

While the current price will keep moving, it is the easiest piece of information to obtain – just look online. We’ll use Friday’s close at $80.06 for our calculations.

The final price is the price when the office closes. Just like any future date, the price could be higher or lower than today’s price. We’ll use today’s closing price $80.06 as the best estimate for our calculations.

The discount is a bit like the price of a house at auction, it all depends on how others participating feel on the day. The discount range for the RIO offer is between 8% through to a 14% discount to the final price. Again, no one knows, but we’ll use the most conservative numbers for our calculations being a 14% discount.

Calculations:

If we buy new shares today on the market, we will pay $80.06*.

Tendering shares into the offer:

If we intend to tender these shares into the OMBB offer at the maximum discount of 14% (most conservative calculation) that’s $80.06 x 0.86 = $68.85 known as the ‘Tender Price’.

In other words, we’re expecting to lose 14% on the shares we buy today – buying shares on the market today for $80.06 and expecting to receive a total of $68.85 in return in about seven weeks’ time.

Capital Return:

When selling the shares into the offer we are paid two separate amounts for our shares;

1. the capital component; and

2. a ‘special’ dividend.

The capital component is fixed at $9.44.

This means we buy the shares at $80.06 today and sell them for $9.44 = $70.62 loss per share.

Special Dividend:

The special dividend is the difference between the Tender price and the capital component of $9.44. In this example, the Tender price is $68.85 – $9.44 = $59.41.

The special dividend is fully franked, and this is where it all starts to get interesting.

A $59.41 fully franked dividend has $25.46 franking credits ($59.41 / 0.7 – $59.41).

Franking credits:

There is $25.46 of franking credits from the special dividend per share.

Final Numbers:

The shares are bought for $80.06 today.

Based on the example prices above, the total amount coming back is $94.31 ($9.44 + $59.41 + $25.46).

That’s a total selling price $14.25 higher than today’s purchase price, or 17% ($14.25/$80.06) possibly achieved over the next seven weeks.

Words of caution

Different entities have differing tax treatments that impact investor’s net returns. See the ATO’s current income tax brackets here.

Not all investors are eligible for franking credits and this can vary depending on other positions held within a portfolio. This is not personal advice. Consult with your broker and taxation specialist to see whether you’re eligible for the franking credits and how this offer may impact your personal circumstances.

Email accounts@arrowsg.com.au for more information on this offer and similar trading opportunities.

*It is important to note that the share price will vary from the time of calculation until the offer closes.