FirstGroup cash call shows deleveraging imperative

May 20, 2013

By Dominic Elliott

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It’s shaping up to be the year of the rights issue in Europe. FirstGroup’s 615 million pound ($1 billion) cash call suggests companies are biting the bullet and exploiting the rise in equity markets to repair their balance sheets. The jumbo issue from the UK rail and bus operator comes after similar fundraisings from the likes of Commerzbank, Dutch cable company KPN and travel operator Thomas Cook. Other distressed companies should look to delever while they can.

FirstGroup’s woes were caused by a lack of investment, spluttering business performance and, above all, too much debt. The rights issue tackles the latter head-on and gives the owner of the U.S. Greyhound bus brand financial headroom to address a capital expenditure shortfall accumulated over the last few years. FirstGroup’s ratio of debt to EBITDA should fall from a precarious three times at the end of March to two times by the end of next year. That should prevent a ratings cut below investment grade, which would have added 50 million pounds in funding costs per year, according to Espirito Santo. A suspension of the dividend will also preserve needed cash.

The high level of indebtedness meant that FirstGroup had few options. A hybrid issue – as used by KPN – wouldn’t have reduced the debt pile. Yet like other companies’ recent rights issues, FirstGroup had to price at a steep discount – 39.5 percent to the theoretical ex-rights price (TERP). That’s in line with those offered by Commerzbank and KPN. Somewhere between a 35 percent and 40 percent discount to TERP appears to be the new price for a distressed company hoping to sell a sizable chunk of shares.

This is a defensive move from a position of weakness. Companies need to show that such fundraisings are a last resort. The inevitable management scalp comes with the departure of Chairman Martin Gilbert, after 27 years. Ironically, Aberdeen Asset Management failed to persuade management of the virtues of a rights issue two years ago, when the shares were double their current level.

With investors looking ahead to economic recovery, the window for dilutive fundraisings is open. Equity markets are fickle. Gilbert’s experience shows the merits of being opportunistic.

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