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Afterpay-Square: What's next for shareholders?

Lewis Jackson  |  26 Aug 2021Text size  Decrease  Increase  |  
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On a day in the not-too-distant future, Australian tech darling Afterpay will vanish from the ASX and be replaced by American payments giant Square.

Under the terms of the deal, Afterpay (ASX: APT) shareholders will be given the option of taking shares in Square (SQ) listed on the New York Stock Exchange or taking locally listed Square CHESS Depository Interests (CDI).

But what is a CDI? How will Afterpay shares be exchanged for Square shares? And what happens to investors who hold Afterpay through a big ETF like Vanguard Australian Shares (ASX: VAS)?

Morningstar has spoken to experts and pored through documents to answer these questions and more. And for those who aren’t sure whether to stay or go, see here for Morningstar’s valuation of Square.

CDIs: Middlemen of the investing world

CDIs exist because countries have different rules for trading shares. Australia uses an electronic system called CHESS, where shares are registered in the investor’s name. In the US, where Square is incorporated, shares are registered to a third-party custodian.

Arcane distinctions like this means shares exchanged via Australia’s CHESS aren’t recognised in some countries, including the US.

Chess Depositary Interests (CDIs) solve this issue by acting as middlemen between Australian investors and foreign companies. Through a CDI, Square’s shares can be traded on the ASX in a way recognised by US authorities in three simple steps.

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First, Square will transfer shares to the imaginatively named CHESS Depositary Nominees (CDN), an ASX subsidiary. The CDN then creates CDIs corresponding to those Square shares, usually on a one-to-one basis, but other ratios are possible. Finally, Square CDIs join the ASX and are traded normally.

Square isn’t the first to use this arrangement. Companies such as Resmed (ASX: RMD), Janus Henderson (ASX:JHG) and Unibail-Rodamco-Westfield (ASX: URW) all trade with this structure.

Almost like real shares

Investors holding a CDI get “beneficial ownership”, which covers all the economic benefits of holding shares such as dividends.

CDN keeps legal title, but this has limited impact practically. Square will still contact CDI holders directly for the purposes of dividends and corporate actions. Shareholders can buy and sell Square CDIs through their broker as they would a normal stock.

The main difference is CDI holders will not be able to vote at Square shareholder meetings, although they can instruct CDN to vote on their behalf.

Not that CDI holders will miss out on all the AGM perks—Square’s 2017 and 2019 meetings were held virtually.

Investors also have the security that should they change their mind, they can swap their Square CDIs for the NYSE version at any point.

For those Afterpay shareholders who opt for CDIs, there will be very little administrative work, says John Winter, chief executive at broker Superhero.

In the lead up to the acquisition finalising next year, Afterpay shareholders will hear from their broker or registry asking whether they want Square CDIs or Square NYSE shares, he says.

When the acquisition closes, investors should simply receive Square CDIs or Square shares in their broking account. Winter says there could be delays of a few days.

Afterpay shareholders will receive 0.375 square shares for each Afterpay share they own. It’s expected Afterpay shareholders will own 18.5% of the combined company.

The deal is an all-scrip, stock for stock swap. Afterpay shareholders will receive 0.375 shares, regardless of the price. Since shares prices will fluctuate between now and 2022, the final value of the Square shares investors will receive won’t be known until the date of the deal.

In the case that Square opts for its CDIs to be at a ratio different than 1:1, the number of CDIs investors receive vary accordingly. The details of the listing have yet to be confirmed by Square or Afterpay.

Investors should quality for “roll over relief” says Winter and it’s unlikely there will be any tax liability associated with the change.

As with any US security, Square CDI holders will have 30% of their earnings withheld by the US tax office. Investors can reduce this to 15% by submitting a W8-BEN form.

Square won’t be in all Aussie equity ETFs

Afterpay has gone from ASX minnow to a member of the ASX 50 but Square’s place on the ASX will depend on the appetite for CDIs among investors, says Russel Chesler, head of investments and capital markets at VanEck.

The number of Square CDIs that join the ASX in 2022 will be determined by how many investors opt for them. In a hypothetical world where all Afterpay shareholders opt to take shares on the NYSE, there would be nothing to list on the ASX.

S&P Dow Jones Indices, which constructs the S&P/ASX 200, then includes shares in the index based on to the number of CDIs issued.

“The extent to which Square will be in the ASX 200 will depend on what investors choose,” says Chesler.

“I would guess many will default to the CDI but when it comes to institutional investors it will come down to whether holding Square is the right investment for them.”

He says there will be notice closer to the date clarifying how many CDIs are being taken up. Index providers like S&P will then recalibrate their indexes. The exchange traded funds that track those indexes will be given advance warning so they can adjust in turn.

Not all Australian equity ETFs will include Square because of special restrictions on what companies can be included, says Chesler. VanEck will not be include Square in its Australian Equal Weight ETF (ASX: MVW) because index rules require foreign companies earn at least 50% of revenue locally.

The index tracked by the BetaShares Australia 200 ETF (ASX: A200), the Solactive Australia 200, does not exclude CDIs and foreign domiciled companies, according to documents viewed by Morningstar.

Duncan Burns, head of the equity index group at Vanguard says that in cases of a foreign acquirer establishing a secondary listing via CDIs, shares are usually just replaced at or close to benchmark weight, leaving the index largely intact.

Vanguard does not comment on specific securities.

Once Square joins the ASX, its place on the index will depend on what investors do with their CDIs. If investors are happy holding onto their CDIs, they should trade with lots of liquidity like Resmed. However, if investors start swapping their CDIs for US-listed stock, the number of CDIs would shrink, taking Square’s position on the ASX with it.

It’s not the first time it has happened. The CDIs of Unibail-Rodamco Westfield have steadily shrunk as investors opted for the foreign listed shares. Singtel, the Singaporean telco giant that owns Optus, delisted in 2015 in the face of persistently low investor demand for their CDIs.

More details will be clarified over the next few months and until then Winter recommends Afterpay shareholders rest easy.

“There’s no way anyone will be short-changed through the process,” he says.

“Every Afterpay shareholder will get treated as per the terms of the deal.”

The deal is expected to be completed in the first quarter of 2022.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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