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As journalist Kate McClymont documents in her excellent book about Eddie Obeid, the New South Wales factional kingmaker used dilutive discounted shares issued in the 1980s to sneakily secure control of the publishing company that owned Sydney’s powerful El Telegraph newspaper.

The property rights of his fellow shareholders at the time were abused, as some claimed to not even know about the cheap share offers Obeid himself was snapping up.

And so it goes in 2014 with public companies that are still using institutional placements, which are banned in the UK, to dilute the collective ownership position of Australian retail investors.

As The Australian Financial Review’s Chanticleer columnist Tony Boyd noted in today’s paper:

“Investment banks handling accelerated capital raisings, which involve a placement and share offer, should use their discretion to give retail a proportion of the issue equal to their ownership of the register.

“This means the pre-placement share ownership split sets the size of the Share Purchase Plan (for retail). It is particularly important when companies offer heavy discounts to the volume weighted average price. If the split is not fair there is a transfer of value between shareholder classes. This is really a tax on retail to provide institutions with a financial benefit handed out by the investment bank.”

So how does all this work in public company land today?

On Monday this week, struggling agribusiness operator Elders announced an earnings upgrade, along with a $57 million capital raising. The raising included a $10.2 million placement of new shares to “institutional and sophisticated investors” at just 15c, a heavy 28% discount to average trading over the previous month.

With Elders shares now trading at 21c, the lucky recipients of these 68.25 million new placed shares are already enjoying a profit of 40% or some $4 million.

In hindsight, there simply shouldn’t have been a placement component at all. Instead, all existing shareholders should have been treated equally with an opportunity to buy new shares at 15c. If shareholders didn’t want the stock, their entitlements should have been sold off to the highest bidder on market and later in a bookbuild.

“This is a rare example of underwriters and their institutional sub-underwriting clients losing out on a capital raising.”

The best historical example of how capital raisings dilute retail investors came from Wesfarmers in 2009 at the height of the global financial crisis.

That particular $4.7 billion capital raising involved paying a staggering $200 million in underwriting fees to guarantee the $1.9 billion institutional component of its three-for-seven entitlement offer, which was almost 40% in the money when it closed. Given the issue was heavily discounted at $13.50 a share and the risk was alive for less than 48 hours, this was money for jam for the investment bankers’ club.

The $2.9 billion retail component of the raising wasn’t underwritten, but the 474,000 small Wesfarmers investors collectively only applied for $1.8 billion worth of shares and were even scaled back to $1.7 billion on the so-called “overs” component.

Given the share price is $43 today, the dilution from allowing $1.2 billion of retail entitlements to lapse has collectively cost Wesfarmers’ retail investors about $2.2 billion on 89 million new shares that were never issued. There was no compensation either, as it wasn’t renounceable, something more common in current offers, although not embraced by Elders.

Even worse, Wesfarmers further diluted all investors by adding in a selective $900 million institutional placement to Colonial (CBA) and American giant Capital at the bargain price of $14.25 a share.

With the stock now at $43, Colonial and Capital have made $1.8 billion on the placement, which is straight dilution for all Wesfarmers shareholders.

Amazingly, the Wesfarmers retail offer document (see page 9) assumed only a 15% take-up rate so the board was planning for huge dilution from non-participation and didn’t market the offer well.

In hindsight, it would have been better for Wesfarmers to suspend dividend payments from the beginning of 2009 and instead paid down debt from its rising cash flows.

The same approach should have been taken by Arrium (the old BHP spin-off OneSteel), which has paid out 51c in dividends since the GFC but is now embroiled in a teetering $754 million emergency capital raising at 48c to pay down its $1.7 billion debt.

The company today disclosed that institutions only took up 79% of their entitlements and the stock came out of suspension and promptly crashed 23% to 42c in morning trade. Oh dear.

With a $98 million placement component and the $289 million retail offer component still to come, this is a rare example of underwriters and their institutional sub-underwriting clients losing out on a capital raising. The cheap shares aimed at the big end of town aren’t so cheap this time around and the Arrium directors up for election can therefore expect big protest votes at the November 17 AGM in Sydney.

Peter Fray

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