What about me? I want my share
September 14, 2009
PORTFOLIO POINT: Rights issues that put retail investors on the same footing as institutions would be fairer and should be the template for capital raisings.
The rash of equity raisings in the wake of the global financial crisis has confirmed what many already knew: that when it comes to heavily discounted capital raisings, institutions are given preferential treatment and retail investors are treated as second-class citizens.
For those condescendingly referred to as "Mum and Dad" investors, there seem to be more and more reasons to be frustrated about the process as they see their holdings diluted because of seemingly unequal opportunities to participate.
For shareholders without cash, the situation is even graver: they are not able to buy any of the inevitably discounted shares offered in the capital raising so they just see their ownership stake in the company diminished with no compensation.
To put some figures around this situation, let's consider a hypothetical company XYZ.
XYZ has earnings of $2 a share, a share price of $20 and therefore a price/earnings multiple of 10. There are 100 million shares outstanding. Total company earnings will be $2 x 100,000,000 = $200 million.
The company wishes to issue a further 10 million shares, which is equal to 10% of its capital. The shares will be issued at $17, a 15% discount, to encourage participation. The issue is fully underwritten (underwriting costs 3% of the issue) and the money will be used to pay down debt that is currently costing the company 7% in interest costs.
So let's see what happens next. Ordinarily there will be three key effects:
- There will be an amount of money raised that can reduce debt and therefore interest repayments.
- Overall company earnings will increase because interest repayments will be smaller.
- Earnings per share will change because there will be more shares on issue and higher earnings.
Effect 1: All the shares are taken up by either investors or the underwriters, so the total amount raised is $170 million, less the $5.1 million underwriting fee - a total of $164.9 million in revenue. This will be used to pay off debt valued at $164.9 million, a saving of interest payments at the rate of 7% annually, or $11.5 million.
Effect 2: Annual debt repayments have fallen by $11.5 million, so earnings will increase from $200 million (before the capital raising) to $211.5 million. You can probably start to see the problem here: earnings have increased by about 5.5%, even though there has been a 10% increase in the number of shares on issue.
Effect 3: The company now has earnings of $211.5 million with 110 million shares on issue (100 million originally plus the 10 million that have been issued). Earnings per share are now $1.92 - down from the original $2. If the company was still priced on a P/E of 10, it would be worth $19.20 a share. Alternatively, you could argue that with less debt XYZ would be less risky and might be priced on a higher P/E.
Overall this is a pretty common overview of what has been happening in the market: 10% more shares issued, a 15% discount to the market price and the funds being used to pay down debt.
Before looking at a couple of seemingly unfair capital raisings, I think it is worth remembering that a shareholder is a part owner of a business. The board and management that organise capital raisings are there to look after the needs of the business owners, the shareholders. Retail shareholders should not suffer from any inferiority complex, they are the part owner of a business and deserve to be treated with respect.
National Australia Bank had a recent share purchase plan issuing shares at $21.50 a share. Institutions bought $2 billion worth of shares at this price, with "eligible ordinary shareholders" entitled to apply for up to $15,000 worth under a share purchase plan (SPP), up to a total value of $750 million.
NAB received offers of about $2.6 billion under the SPP - which saw these scaled back by about 70% to the total of $750 million. Shareholders received 202 shares each, valued at $4343.
The $2.75 billion raised equates to another 127.9 million shares on offer, or an 8% increase in the number of shares on issue. That means shareholders with more than 2500 shares and who participated in the SPP had their total ownership of the company diluted.
With NAB shares currently trading at $28.60 the total "wealth" distributed to the institutional shareholders who bought $2 billion worth of shares at $21.50 is $660 million, and the total wealth for retail shareholders who bought $750 million worth of shares is $246 million.
A Eureka Report subscriber recently asked: "Can anyone please explain to me and to other NAB shareholders why institutional and ?sophisticated' investors can buy up large parcels of shares under NAB's offer when ordinary shareholders will be allotted less than 30% of what we applied for? Apart from the benefits of the discounted shares, our existing shareholding will be substantially diluted. NAB could hardly be congratulated for their fairness to their loyal ordinary shareholders."
We looked in more detail at the share purchase plan that ANZ completed, also noting the potential dilution that took place for investors limited to $15,000.
For the NAB and ANZ offers, a fairer solution would be a rights issue, where shareholders had the opportunity to apply for a certain number of shares based on their current ownership: the ability to apply for one extra share for every 10 owned. It should be noted that a rights issue may cost slightly more for the production of the related documents, and might take slightly longer, but it would have the benefits of increased transparency and equality.
This does not help those shareholders who don't get to participate at all; they see their holding in the company diluted with no benefit to them. A renounceable rights issue on the other hand can bring equality for those people not participating. They are given the right to participate and, if they choose not to, their rights are sold. The sale of the rights generates some cash, which compensates them for the dilution of ownership that comes from not participating in the capital raising.
Boards would probably argue that running a rights issue costs slightly more and takes longer than an SPP, which limits the capital raising to $15,000 per shareholder, although I would suggest that these matters are not material. Retail shareholders are no different than the other shareholders and therefore capital raisings should take into account how to best serve them all at the same time.
Sigma has recently announced a one for three capital raising, to raise $297 million. It is using a fully renounceable rights issue. This allows shareholder participation in proportion to their holding, and allows shareholders who do not wish or are unable to buy shares at 16% discount to sell their rights into the market.
The offer was announced on September 7 and closes on October 2: essentially a four week window.
There will be $132 million of shares offered to institutional investors and $165 million to retail investors, a reversal of the NAB offer that saw $2 billion going to investors and only $750 million to retail investors.
Overall this seems to be a fair, efficient and transparent way of raising money that does not disadvantage any existing shareholders.
The capital raising from Sigma is in stark contrast to many others, offering retail investors, including those that do not participate, an equitable outcome. The model it is using to raise the funds, a renounceable rights issue, should be the template for all listed companies.
Some companies will argue that the longer time and greater costs involved in undertaking such a rights issue makes it more difficult. Surely the onus is on the regulators and companies to ensure that such a model can be used by companies efficiently and to ensure the fairest outcome for all shareholders who, after all, are the owners of these companies and should be treated as such.
Scott Francis' articles in the Eureka Report