Australia | May 15 2007
By Chris Shaw
Santos (STO) has had a difficult time of things over the past 12 months, particularly when one of its exploration wells resulted in huge mud slides and caused significant damage not just to the surrounding area but to the company’s share price and reputation.
Management are attempting to do what they can to improve returns for shareholders, the latest initiative being a $300m off-market buyback of shares that will unlock some of the value in the company’s large store of franking credits.
Merrill Lynch, which rates the stock as a Buy, estimates there is around $738m or $1.23 per share in franking credits on the company’s books, so the deal, structured as $2.79 in capital and the rest a fully franked dividend, should use close to $100m of that balance.
This leaves the way open in the broker’s view for the company to make similar such buybacks in the future, which should prove a positive for shareholders given the broker expects the current deal will be slightly earnings accretive.
Assuming it has a positive impact the deal is likely to be well supported, so shareholders need to determine whether it is in their interests to accept for all or part of their holdings.
FNArena has received some analysis on this question by a professional financial planner/expert. One could argue the analysis has come in timely as to qualify for the 45-day holding period required to utilise ranking credits shareholders would have to be a Santos shareholder by the close of trading today, May 15th.
If it was assumed the share price for Santos was essentially unchanged at around $13.00 at the close of the buyback period on June 29th, the buyback price would be at a discount of around 14%, suggesting a price of $11.22. Of this, $2.39 would be the capital component, so the fully franked dividend would equal $8.43 and franking credits would be $3.61.
For a non taxpayer this would imply a profit of around $1.64 per share after costs, which is a return of about 12.5%. It all sounds great, but there are other factors investors must take into account.
Firstly, if there was a chance for a 12.5% return in a month and a half many people would be interested, implying the offer is most likely to be scaled back. There is also some share price risk, as no one knows today what the Santos share price will be at the end of next month. As an example, if there was a 50% scale back on acceptances and the stock fell $1.00 between now and the end of June a shareholder would make about 40c per share on those accepted but lose around $1.14 per share on the balance of its holding, making the deal much less attractive.
Additionally, the company has advised it has yet to receive a ruling on whether or not any capital loss for shareholders as part of accepting would be able to be used this year to offset capital losses or would need to be held over until next year.
Assuming the loss can be used this year then superannuation funds could expect to generate a gain of about 9% for every share bought back if they can use the loss to offset capital gains this year or 6% if they are applied against previously discounted losses.
Given many other shareholders would have a less favourable tax position than do super funds, the returns would therefore be lower depending on the individual tax rate. As a result, non super funds may not find the deal attractive enough, particularly given the risks involved.
Following the announcement of the buyback there has been no change to broker ratings on the stock, Macquarie pointing out the stock remains above its valuation and Credit Suisse noting the company’s production outlook doesn’t point to significant upside potential.
Overall, the FNArena database shows the stock as rated Buy twice, Hold five times and Reduce/Sell three times, with an average price target of $11.10. Shares in Santos today are slightly weaker in a down market, as at 11.20am the stock was 8c lower at $12.90.
Shareholders should consult with their stock broker or financial planner about what to do regarding the Santos buyback offer.