What: The shares of Telstra Corporation Ltd (ASX: TLS) rose 11.5 cents or 2.21% to $5.56, helping to boost the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) to a late afternoon rise of 0.7%. The rise in Telstra was partly attributable to a higher dividend and the intended buyback of $1 billion shares.
What is the intention of a buyback?
The first point is that shareholders are given the choice of whether or not to sell. The advantages are many and varied including:
Making good usage of surplus funds.
Lifting earnings per share (EPS).
Providing shareholders a price nearer to asset value if the share price is below net tangible assets (NTA) backing.
What does Warren Buffett think of share buybacks?
Buffett said: "Charlie (Munger) and I favour repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business: second, its stock is selling at a material discount to the company's intrinsic business value, conservatively calculated".
Telstra shareholders will be hoping that the second condition holds true. However, valuation is in the eye of the investing community who have price targets for Telstra ranging from $4.35 up to $6.00 per share. Certainly the company meets the first requirement by generating massive free cash flows (FCF) that have allowed for an increased dividend and any mid-size acquisition opportunities. Guidance for FY2015 is for $4.6 billion to $5.1 billion of FCF.
An additional reason for this share buyback
In a video broadcast, Telstra chief financial officer Andy Penn stated that the company had a one-off increase in the franking balance of $258 million. With a looming reduction in the company tax rate and hence the value in the franking credits, he was conscious of returning these credits to shareholders as soon as possible. Hence the buyback is structured so that the fully franked dividend component is equal to the difference between the buyback price and a capital component of $2.33 per share.