Tox Free Solutions (TOX.ASX) – M&A + franking credits – 1%-9% upside

Current Price – $3.43

Expected Payout – $3.425 (consideration) + $0.05 (normal FY18 dividend) + $0.27 (potential value of franking credits to certain Australian investors)

Upside – 1%-9%

Expiration Date – Q2/Q3 2018

Announcement

This idea was shared by member M and it is mostly geared towards Australian investors, but non-Australian investors still have the opportunity to make a good IRR return. 

 

Cleanaway Waste Management (CWY) entered into a Scheme Implementation Deed to buy Toxfree Solutions (TOX) for $3.425 cash plus a $0.05 normal FY18 dividend (Announcement) in December 2017. The Board of TOX unanimously recommends shareholders vote in favour of the transaction. TOX shareholder approval for the transaction is subject to a vote at the Scheme Meeting which will likely occur in Q2/Q3 2018. I will not deliberate the merits of the transaction as I have too little knowledge about the industry for my opinion to generate any incremental value. There are standard transaction conditions and risks highlighted in the Announcement link above. If the transaction fails to complete significant losses may be incurred. I think the risk of TOX or CWY walking away from the transaction is low for the following reasons:
  • Unanimous recommendation from the Board of Directors
  • Advanced diligence was undertaken prior to the announcement (i.e. no further diligence conditions moving forward required)
  • Certainty of value to TOX shareholders 100% cash
  • CWY Institutional Capital Raise to fund the transaction has been completed
  • In-depth understanding of each other’s businesses and potential synergies due to both having operations in Australia
Australian taxation of dividends is per an “imputation system” whereby investors are not double taxed on dividends where company tax has already been paid. The company tax rate is 30% in Australia so a $1.00 dividend would have $0.30 of tax credits attached, a $2.00 dividend has $0.60 franking credits attached etc. As such, an opportunity exists for certain Australian residents subject to their personal tax rates to receive an additional benefit from the value of franking credits paid if a special dividend that forms part of the $3.425 consideration. The quantum of the special dividend has not been announced. According to my calculations if TOX was able to distribute the full value of the franking credits a potential special dividend of up to ~$0.60 could be paid. This special dividend of $0.60 would have ~$0.25* in franking credits attached to it. Under this scenario, the value of the transaction consideration would be as follows to certain TOX shareholders that are able to use the full value of franking credits.
  • $3.425 cash (comprised of $2.825 capital return and $0.60 special dividend)
  • $0.05 normal FY18 dividend
  • $0.25* value of franking credits to certain TOX shareholders associated with the $0.60 special dividend
  • $0.02** value of franking credits to certain TOX shareholders associated with the $0.05 normal FY18 dividend
  • Total potential value of transaction to certain TOX shareholders $3.745 ($3.425+$0.05+$0.25+$0.02) vs current share price $3.43
Worth noting, that the quantum of the special dividend is subject to the Board’s discretion and various legislative requirements (i.e. the special dividend might be lower than $0.60 in my example).
 
How can non-Australian investors take advantage of this situation? 
Unfortunately, the value of franking credits is irrelevant to non-Australian investors. However,  certain Australian investors will eventually notice the added value and based on past transactions the share price typically rises above the $3.425 offer consideration. There is no hard and fast rule but if you look at recent examples of similar transactions the share price should head above $3.50. Thus, an opportunity exists for non-Australian investors to by TOX in January 2018 for $3.43 before the market acknowledges the potential franking credit value and drives the price above $3.50 (likely February / March 2018 when further information relating to the special dividend might be released). Non-Australian investors can potentially make 2%+ return in under 2 months (i.e. 12%-24%+ IRR) by selling out if the share price rises. Non-Australian investors should sell well before the transaction completes as waiting for completion and the special dividend is unlikely to be beneficial.
Please Note: The quantum of the potential special dividend, the tax treatment of franking credits and risks the transaction does not complete are extremely complex matters. The scenario above is hypothetical and based on what has occurred in other recent transactions. This post is for educational purposes, is general in nature, does not constitute financial advice and investors should do their own research or speak to a financial, legal or tax advisor to discuss their personal circumstances prior to making any investment.
 
*$0.25 franking credits calculation = ($0.60 / (1 – 30% Tax Rate)) – ($0.60) 
**$0.02 franking credits calculation = ($0.05 / (1 – 30% Tax Rate)) – ($0.05) 
Published on: January 5, 2018  •  Published by:
Category: M&A  •  Member Ideas

4 COMMENTS

  1. MM90

    An example of a similar transaction in 2017 would be Seymour Whyte (ASX:SWL) which had an offer from VINCI for $1.285 per share ($0.84 cash and $0.445 special dividend). Including the franking credits on the $0.445 special dividend, the offer was worth $1.475 to certain Australian investors. What happened? The market price rose to ~$1.39 per share so non-Australian investors could have made ~7% in a matter of a few weeks if they bought at the $1.285 offer price and sold at ~$1.39. Certain Australian investors on low tax brackets that bought at $1.285 made ~14% but they needed to take on risk to hold shares for a few months until the deal completed (i.e. risk the deal falls over).

  2. M

    Entered this stock at an average entry of $3.39 today and confident it will rise ~2%+ once the Board announces an update on the transaction and value of the special dividend. This update is before the end of Jan 2018 so assuming a 2-week hold the IRR is expected to be 50%+.

  3. M

    The Special Dividend ended up being $0.58 vs. an estimate of $0.60 (see https://www.asx.com.au/asxpdf/20180302/pdf/43s4g51dzxlpkc.pdf). The largest upside is obviously for Australian investors on low tax brackets due to large franking credit benefits.

    I will exit this trade in the next week or so once the stock trades up due to the market finally realising the value of franking credits. The IRR on the trade will be lower than first anticipated due to a longer hold period but the benefit was an additional $0.05 dividend that was earnt on 1 March. Overall, I am happy with the way this trade has performed. Given the extreme volatility of global markets over the last month this stock has held steady the entire time and delivered superior uncorrelated risk-adjusted returns.

  4. M

    This transaction closed and payment of funds is due in 1-2 weeks. It didn’t play out exactly to plan with a slight delay extending the hold by a month or so and lower upside for non-Australian investors. However, as expected the situation was highly profitable and low risk for certain investors in Australia. In summary, bought @ an average of ~3.40 and proceeds will be ~3.675 including the franking credit so ~8% return in 4 months or 25%+ IRR. I think of more importance despite the volatile period since February in global markets this investment did not drop further than ~1% of the price it was bought at.

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