It seems the perfect marriage of interests: companies have an equity raising to pay off debt, and investors get cheap shares.
Much has been written about shareholders making money on equity raisings this year and several billion dollars worth of raisings are currently underway (see table.) But some investors are still underwater on last year’s raisings. Leighton Holdings raised $700 million from an issue at $35.35 last September and its shares are currently under $25.
The March rally turned the odds in favor of shareholders, with companies offering new shares at a discount of 10 to 20% and investors scrambling for shares because they feared missing the chance to buy at the bottom.
Some investors might question the wisdom of their company selling its shares at a 20 per cent discount, is the family silver being sold at stainless steel prices? However, many company boards feel they have no choice when banks are unwilling to lend to corporates or only at exorbitant rates. And Bell Direct equities analyst Julia Lee says so much cash is sidelined by nervous investors that companies have to offer big discounts to draw it back into shares.
UBS has arranged many of the largest equity raisings and its co-head of equity capital markets Simon Cox dates the phenomenon from the beginning of October when the Reserve Bank cut interest rates.
He says the economic downturn was so sharp that companies which had been comfortable with their level of debt in 2007-early 2008 suddenly had to simplify their balance sheets but found debt markets weren’t interested. He says even the largest Australian corporates have found the US debt market is closed to them.
Cox says investor sentiment towards raisings changed markedly from the second week in March when the market began to rally. Until then, investors had been nervous about the economic outlook and worried whether some companies would survive.
“But now they are looking beyond that, earnings are not going up but people are happy to re-rate and pay higher price-earnings multiples in expectation of earnings recovery at some later date.”
Cox sees one significant signal of optimism as the increasing willingness of institutions to sub-underwrite the retail component of equity raisings. Lead arrangers such as UBS approach the major institutions first, often giving them 24 hours to decide whether to participate in a raising, while the offer to retail investors typically comes three or four weeks later.
The sub-underwriter takes a risk that the market will turn against them in that time, and Cox says more institutions are comfortable taking that risk.
“It’s a true barometer of investor sentiment towards the market. The direction of this rally is evidenced by willingness of institutions to sub-underwrite the longtail risk in a retail rights offering,” he says.
Most companies use the proceeds of equity raisings to pay down debt and that concerns some analysts who caution investors to weigh the opportunity for cheap shares against the underlying value of the company.
Julia Lee says investors have to consider each offering on a case-by-case basis and look at where the money is going.
“We will probably continue to see capital raisings in the property sector because of asset revaluations,” she warns.
“If the commercial property market continues to fall and we then see asset revaluations then the underlying business will be under pressure.”
The structure of an equity raising will be dictated by how much the company wants to raise and does not always favor the retail investor. A listed company may not increase its capital by more than 15% in a year unless it gets shareholder permission or makes the same offer to all shareholders. That will usually be via a rights issue.
A company issuing less than 15%, such as with the bank offerings last year, can make different offers to different classes of shareholder such as through a share purchase plan to retail investors. A plan usually allows shareholders to buy up to $5000 of stock but companies have increasingly been allowed to offer up to $15,000.
Lachlan Partners investment officer Helen Breier says smaller investors can find their holding diluted if they cannot buy enough shares. As raisings become more popular, shareholders are increasingly finding requested allocations are being scaled back.
Investors might also see offerings distort their portfolios. For example, both Stockland and GPT are hitting shareholders for the second time in months, Stockland offered shares at $5.30 in October and $2.70 last month and GPT’s offer was at 60 cents in October and 35 cents this month. However, Helen Breier said shareholders are more comfortable with building up portfolios by adding new shares to their existing holding. Last year share prices were likely to fall when an issue was announced because investors sold shares with the intention of topping up again from their allocation.
Now that many of the top 50 companies have gone to the market, Simon Cox says further raisings are likely to be from smaller companies and so the amounts raised will be smaller.
So far there are few signs of investor fatigue, although concerns have been raised that the sheer amount of raisings is depressing the wider market. Julia Lee notes that companies are getting money that might otherwise be invested straight into the market.
“Usually it has held back the market, but having said that, it is a very cheap way for investors to obtain more stock,” she says.