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Caution urged on corona capital raising

Nicki Bourlioufas  |  18 Apr 2020Text size  Decrease  Increase  |  
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Rights issues—packages of shares companies offer at special prices to existing shareholders—are growing in number amid the coronavirus economic slowdown.

“Ask whether the issue price is below fair value and if so, it may be worth considering,” says Morningstar's head of equities research, Peter Warnes.

"But if the issue price is above fair value, then it may not be prudent to participate."

These plans entitle existing shareholders to buy additional shares at a discount, with an upper dollar limit and sometimes in proportion to a shareholders existing holdings.

But will they always be worthwhile?

Many well-known companies—including hearing technology company Cochlear (ASX: COH) and insurer QBE Insurance (ASX: QBE)—are offering existing shareholders the right to participate in equity raisings, including an institutional placement and a share purchase plan (SPP).

Other companies clearly strapped for cash, such as Flight Centre (ASX: FLT), are following suit as is data centre operator NextDC, IDP Education, retailer Kathmandu and travel group Webjet.

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Shareholders should analyse each offer carefully and compare it to a company’ fair value before deciding to participate, says Warnes.

Investors should also question why some of these companies are raising capital now, and whether it's prudent to increase their holdings at this time. With plenty more rights issues to come, investors need to be very selective.

“You need to examine the weight of your existing shareholding in that company in your portfolio, and ask whether you would want to increase that weighting if there wasn’t a rights issue,” says Morningstar’s Warnes.

“If not, then it may not be worth participating. A bargain is something you don’t need at a price that you can’t resist. So, in other words, it's important for investors not to get overwhelmed by the price and only buy something if they need it.”

Weighing up offers

Drew Meredith, director and adviser at Wattle Partners, is generally sceptical about rights issues, as they are often heavily tilted towards investment banks, institutions and broking houses and their clients.

“But it’s not often that the ‘world is on sale’ like this and there is no doubt some high quality businesses in need of capital for a short period of time," he says.

If you're holding onto the stock for the right reasons—because it's a quality company not for emotional reasons—Meredith is optimistic about such offers but applies a standard caveat.
"This discount must be at least 10 per cent of the share price nearing the close of the offer,” says Meredith.

“The only way to protect yourself from [paying more than market price] is to wait until just a few days before the close before making your payment."

Given the extreme volatility of markets lately, he says the 10 per cent rule means you have the potential to sell your additional holding at a profit once the shares are issued, highlighting Cochlear a a good recent example.

Cochlear is offering retail shareholders the opportunity to buy up to $30,000 worth of shares as part of a $50 million SPP. It has raised $880 million from institutions and shares are being offered for $140 compared to a market price of $194 as of 17 April—a discount of around 30 per cent to Morningstar's $129 fair value estimate.

'Keep the lights on'

Meredith urges investor to only support such offers from high quality companies where the current economic situation presents only a short term need for additional capital.

"Such as needing capital to stave off their creditors, or to keep the lights on should the implications last for longer than the predicted six months," he says.

Some offers are coming from companies clearly facing significant hurdles, including Flight Centre, which is offering shares for $7.20.

Morningstar analyst Brian Han recently cut his fair value estimate on Flight Centre by 48 per cent to $18.00 a share. The doubling of the share base as a result of a $700 million capital raising was a key reason for this drop, along with cuts to medium-term earnings estimates.

But despite the business disruption the pandemic has inflicted on Flight Centre, Han says the company's issue price is attractive.

"It provides Flight Centre with a liquidity lifeline to navigate the highly uncertain near-term environment, while affording investors a rare opportunity to invest in a fundamentally solid company with significant upside leverage when conditions recover.”

But Wattle Partners’ Meredith isn’t so sure. He says investors need to be aware of the company’s cash flow position, and asks: “how much money is the company burning on a monthly or quarterly basis while sitting idle amid COVID-19 restrictions?

He says travel booking companies Flight Centre and Webjet are prime examples. 

"Will they just need additional capital in a few months’ time, in which case the share price will likely fall further?”

QBE's US$825 million ($1.3 billion) rights issue in recent times, the insurer's $8.25 offer price well below its recently revised fair value of $11.

Warnes says retail shareholders are being offered 10 per cent of the total issue, in line with their ownership of existing stock, so “existing shareholders are being treated fairly.”

Morningstar analyst Nathan Zaia recommends shareholders subscribe to the SPP because the offer price includes a "meaningful margin of safety".

is a Morningstar contributor.

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