Alexander Smith’s Profile
Doting investors bail out UK Plc
Like doting parents of teenagers who have spent their allowance and keep coming back for more, shareholders have so far been extraordinarily forgiving when stumping up cash to bail British companies out of debt. At some point, however, they will lose their patience and say “no”.
Housebuilders Barratt and Redrow are the latest to raise cash from shareholders via heavily discounted rights issues, joining a long list of companies who have gone cap in hand to investors for sums of more than 100 million pounds ($163.4 million) since the start of the year.
For now at least, everyone can feel good about the result. A rising stock market since March means shareholders can say they did the right thing in giving companies the cash needed to pay down debt, defend their credit ratings or write down previous corporate follies.
Like others before them, Barratt and Redrow say they’ll use the 545.5 million pounds and 156 million pounds they are raising to strengthen their respective balance sheets.
Companies have few avenues open to them to raise new funding now that banks have largely turned off the tap. The most creditworthy companies have tapped the bond markets, but others have no real option other than to turn to shareholders.
In doing so, they are effectively holding a gun to investors’ heads. If they don’t get the cash they need to refinance debts, they risk breaching bank covenants or failing to meet bond payments. If that happens, shareholders will inevitably lose out.
The alternative is a deeply discounted rights issue. This allows shareholders to redeploy some of the cash they took out of the equity market during the worst of the financial crisis. If they don’t stump up, shareholders face having their stakes heavily diluted.
The recent rights issues have been remarkably similar. Of the 26 deals of more than 100 million pounds this year, the average discount to the theoretical ex-rights price (the price at which the new shares should trade) was 39 percent, according to data compiled by BNP Paribas UK Equity Capital Markets head Ben Canning. Of these, 19 had a discount to TERP of 38 to 40 percent.
So far, investors have been willing to overlook these hefty discounts and the rising fees paid to the underwriters and sub-underwriters. Bookrunners are taking a fee of 3.25-3.5 percent on deals of above 100 million pounds, well above the 2 percent they were charging a couple of years ago.
The banks argue that the fees reflect the increased risk involved in backing these cash calls given the extra market volatility. And with institutions who missed out on the early stages of the equity market rally still falling over themselves to invest, it is no wonder bankers are predicting more rights issues to come.
But at some point this gravy train will grind to a halt. A stock market correction would prompt investors to re-think their willingness to support future offerings.
If the fall is sufficiently sharp, underwriters may even find themselves having to make good on their commitment to buy shares the market does not want. It would probably be better if some investors were willing to say “no” before it gets to that.