The proposed buyout of Santam at R505 a share has been widely described as offering shareholders an attractive premium. Measured against a pre-announcement share price of about R400, that is true. But for long-term investors, the question is not whether R505 is more than R400. The real question is: what happens after tax, and can shareholders realistically replace what Santam has delivered over the past decade?
I am approaching this from the position of an individual shareholder. Few of my clients are exposed to the local equity market, but let’s say one of them is deeply attached to an investment he made in Santam 10 years ago. To illustrate his displeasure with the proposed offer, I am assuming my client purchased Santam shares on October 6 2016 at R214/share and is now forced to accept the offer of R505/share in cash.
Over the past decade, Santam has rewarded my client through both dividends and capital growth. Using Santam’s dividend history, the client who bought in 2016 would have received nearly R135/share in dividends. After deducting the 20% dividend withholding tax, the cash received would have been just over R105/share.
On an initial investment of R214, this means my client received almost 50% of the original purchase price back in cash. The net dividends received equal cash returned of 50% of the initial investment.
Remarkable returns
Viewed differently, Santam generated an average annual after-tax cash return of about 5% on the original investment. The equivalent yield before tax is closer to 6.25% per annum. In other words, if my client is looking to replace Santam’s income stream, he would need a new investment yielding about 6.25% before dividend tax.
Over the illustrative 10-year period, the share price rose from R214 to R400 (the pre-announcement price). That equates to capital growth of about 6.4% a year. Combining the gross dividend return and the capital growth, Santam generated a total annual return of well over 12% for my client over the decade.
That is a remarkable achievement for a mature insurance business.
Now comes the catch.
My client receives R505/share from the offer, resulting in a capital gain of R291/share (R505 minus R214). At the maximum individual capital gains tax (CGT) rate, about 18% of the gain is payable to the South African Revenue Service. The CGT is R52.38, meaning my client will receive a net R452.62 from the offer. He does not have R505 to reinvest, only R452.62. So, the premium offered is smaller than it appears.
Before the offer, my client owned a Santam share worth R400. After the offer and after paying CGT, he has R452.62, an effective increase in investable capital of R52.62 and only a 13.2% improvement on the pre-announcement value. While the headline premium is R105/share, roughly half of that finds its way to Sars.
The CGT trap
The real challenge facing the shareholder is not receiving the cash but replacing what Santam delivered for 10 years — the dividend stream, the after-tax cash income, the capital growth. The obvious question becomes where can we invest R452.62 today and reasonably expect to earn more than 12% a year over the next decade? That is a far more difficult question than deciding whether R505 is greater than R400.
One of the least discussed consequences of takeovers is that they force long-term shareholders to realise capital gains. It’s the hidden cost of a successful takeover. Before the transaction, my client enjoyed deferred taxation and continued participation in future growth. Now, CGT is paid immediately, part of the investment capital disappears permanently, and my client must identify a replacement investment in an environment where future returns are uncertain. This reinvestment risk is real. A quality business that has compounded wealth for many years is often far easier to hold than to replace.
In the short term my client is better off by R52.62, but perhaps not by as much as the offer suggests. However, my client must now find a new home for the capital in an investment generating more than 12% annually on a sustainable basis.
Santam is certainly a meaningful business and its contribution to Sanlam is hardly trivial. If it has been good enough for Sanlam to increase its ownership from a controlling stake to complete ownership, why should long-term minorities be enthusiastic about selling their remaining shares at all?
So the true issue is therefore not whether the offer represents a premium. It is whether the after-tax proceeds of R452.62 can realistically be reinvested at returns comparable to those that Santam has delivered over the past decade. For my client and similar long-term shareholders, that may prove to be the most difficult part of the deal.
