Looking for franking credits? Check your underwear

Thu, 12 May 2016 22:00:05 +0000

Since the budget last week there are changes on the horizon regardless of who wins the upcoming election. There is no denying that the attractiveness of SMSFs have somewhat diminished relative to what they were, however relative to other alternatives they still remain a tax effective method of investing. As a result you could argue that franking credits will become even more valuable to the SMSF community from 1 July 2017.

A quick refresher on franking credits – they are a tax credit passed on by Australian companies who have paid corporate tax. Currently a fully franked dividend is based on a 30% company tax rate, which will also be lowered over time should the Liberal Government win, meaning the quantity of franking credits received per taxation dollar will be less in the future, hence more valuable now.

In summary, now could be a great time to build up your SMSF franking credit balance.

Whilst the majority of ASX200 companies will not be paying another dividend until after their FY16 results, there is potentially another way to gain franking credits and all you have to do is look at your underwear…

Pacific Brands (PBG), the owner of well-known Australian underwear and basic apparel brand BONDS is currently facing an all cash takeover offer from US giant apparel company Hanes Brands Inc (HBI). HBI sees merit in owning the PBG for its dominant market position and for extracting cost synergies through their global platforms.

At NAOS we are of the view that this acquisition will go ahead under the current timeframe (mid-July) because of the following factors:

HBI have a lot of experience in acquisitions, they have done their due diligence on PBG and are comfortable with integrating the business
HBI have secured their funding for this deal
The PBG takeover offer has already been given FIRB approval
There is no delay due to the election

The unknown factors remaining are the shareholder vote, however given the largest shareholder has sold at prices lower than the proposed takeover price within the last two months we can take this as a good sign of their intentions. Another unknown factor, any ‘material adverse change’ in operations, as far as we can see it can only triggered by one of PBG top few customers cancelling all association with PBG in the next 6 weeks. We have no evidence to suggest to this will occur. The yet to be released independent experts report is also a consideration, however with the offer price being higher than the PBG share price at any point in the last 5 years we feel comfortable the independent experts report will show the HBI offer is sound.

So how does this benefit your franking balance? When you get a combination of an all cash offer and an offshore buyer, the deal is typically structured with a special franked dividend as a proportion of the cash proceeds. This is because the offshore buyer has no use for the franking credits. If you take the view that PBG takeover will go ahead then you have the opportunity to gain franking credits as long as you own the stock for the standard ‘at risk’ 45 day period. In this instance we have taken the ‘at risk’ period to mean the effective date (last trading date) and working backwards to get 45 days. According to our calculations you would need to be on the PBG register by market close Friday 13th May 2016.

The numbers:

Wednesday 11th May 2016 close price is $1.135 and the takeover price is $1.15.
Incorporated into the $1.15 is a $0.094 special dividend which is 100% franked
This equates to $0.04 per share in franking credits
In the example where you bought 100,000 PBG shares at Wednesday’s close price you would receive $4,000 in franking credits and make a $1,500 profit in under 2 months.

Investors need to be patient for these sorts of opportunities as the combination of an all cash offer for a company with franking credits by an offshore acquirer don’t come around too often. A well-known example of a successful outcome occurred when global travel giant acquired Wotif in an all cash bid of $3.30 which included a $0.24 fully franked special dividend. A more recent example was the takeover of Australian packaging solutions business Colorpak. It is worth noting these types of takeover offers aren’t always successful as seen when Joe Hockey rejected the Archer Daniels Midland takeover offer for GrainCorp.

One for investors to keep a close eye on is the pending $9bn takeover for Asciano (AIO) by the Brookfield/QUB consortium which could include up to $0.39 per share in franking credits. As it currently stands it is within the 45 day period, so if you purchase AIO shares today and the takeover goes through under the current timetable then you would not be able to benefit from the franking credits. However, NAOS are of the view that the timetable may be extended if the ACCC require more information from their review and/or the ramifications of a government in caretaker mode for FIRB. We believe there is inherent risk in owning AIO before an ACCC decision, however if this decision is favourable and the takeover is delayed due to the election then there may be an opportunity to own AIO and benefit from the franking credits.

Who ever thought tax and underwear would be mentioned in the same sentence.

by Robert Miller, NAOS Portfolio Manager

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Looking for franking credits? Check your underwear