Today’s Australian Financial Review headline blared: “Shareholders burn $7.6 billion as capital raisings bomb”, a fact of which many institutional investors are already painfully aware. The study, conducted by Dealogic and the AFR, neatly proved Warren Buffett’s claim that an investor is better off buying into well-managed businesses at fair prices rather than poorly managed companies at ‘cheap’ prices.
Of the capital raisings considered, Goodman Group (down 82.8%), FKP Property (down 78.7%) and Alumina (down 75.3%) lead the failure list. Although special mention must be reserved for GPT, which managed to fall 61.7% from its already deeply discounted capital raising price of $0.60.
That many equity raisings have proven disastrous for investors should not come as a surprise. Private placements (as opposed to broader rights issues) are little more than a high-pressure, boiler room sales pitch — with the main difference being that the marks aren’t sharemarket novices, but rather so-called sophisticated institutional investors.
Alan Kohler neatly described the private placement process last year in Business Spectator, when he noted:
The common method of raising capital these days is through a discounted placement to institutions. The board and the CFO get the usual investment banker in, they agree on the discount and the fee (usually two per cent), the investment banker looks out the window and quietly pushes the “standard underwriting agreement” across the desk to be signed, the company secretary is despatched to request a trading halt and the Equity Capital Markets sales staff of the investment bank hit the phones the next morning.
The best clients, of course, get called first and eventually the tired and hoarse ECM phone jockeys get to the lesser clients around 9am. The bids are due in by midday.
The fund managers have to make a quick decision based on no new information or promises. The company’s board and management do not disclose in detail what they plan to do with the cash and do not make any forecasts about what return they intend to make on the funds.
The messy process provides a clear example of agency costs which exist for public companies shareholders. Firstly, the purchasers in a placement, fund managers, are spending clients’ money, not their own. Second, for the fund-raising company’s executives, the businesses’ survival (and their reputations) are far more important than flogging off shares for more than they are worth.
Investors will, however, only be able to put up with such a patently unfair system for so long. Poor returns from equity issues will further dampen investor appetites for such raisings to the point where issues need to be withdrawn, as occurred with Ten in February. This development will be ringing alarm bells at local investment banks.
With merger and acquisition activity contracting, equity raisings have become a lucrative source of income for Australian-based banks. Unlike merger advice, placements can occur rapidly, the actual underwriting risk is nominal and the fees are mouthwatering. The best example of the fast money which banks are able to earn by running placements was UBS’ fee take from Commonwealth Bank’s recent $2 billion placement last December.
The raising was steeped in controversy after CBA accused Merrill Lynch (the original bank running the placement) of failing to inform investors of an impending profit downgrade due to higher bad debt provisions. CBA terminated Merrill’s services and the following day and appointed UBS to conduct an underwritten placement at a discounted price of $26 (Merrills had gotten the deal away art $27). UBS were only told about the placement late on 16 December and the deal was wrapped up the following day. According to Giles Parkinson in Business Spectator, UBS would have collected around $33 million for around 12 hours work. (UBS itself confirmed as much when it stated that it only spoke to investors after being mandated by the client and Merrills had been terminated). The $33 million was paid by CBA shareholders.
Equity raisings, and specifically placements, are the investing equivalent of a prisoner’s dilemma. If institutions shun capital raisings, it is likely that their existing equity holding will lose value (equity raisings are usually a last resort after other funding avenues have been extinguished). On the other hand, given the current state of the market, participating in a placement will almost certainly result in negative returns, as noted by the Financial Review.
If the fees earned and subsequent investor returns are in guide, so far, it appears that the only winner from the recent spate of equity raisings have been the financial advisers.