Making capital raisings fair, efficient and transparent
What is the issue?
Australia has a relatively laissez faire system when it comes to capital raisings which has aided capital formation, but is subject to abuse. Our system has proven highly lucrative for advisers and under-writers (refer ownership-matters-research-paper/media/Ownership-Matters-research-paper.pdf” target=”_blank”>ownership-matters-research-paper) but also led to substantial dilution and value leakage for shareholders.
The first point to observe is that the opportunity to participate in a capital raising is a valuable right. However this right can easily be rendered worthless where directors exercise their discretion to issue shares in ways that dilute existing owners through placements or non-renounceable entitlement offers. Wherever possible, capital raisings should be pro-rata and respect the pre-emptive rights of owners. Owners should be given the opportunity to ‘renounce’ their entitlement to buy shares in companies they own by selling their rights on the open market.
The $100 billion of capital raisings in the 2008 and 2009 GFC period featured many placements and non-renounceable offers which helped issuers raise capital quickly but were often regarded as unfair to incumbent investors.
The lack of disclosure about who was issued these placed shares remains a problem today. Why not require public disclosure of any recipient of shares in a non pro-rata offer?
Prospectus requirements have subsequently been loosened since the GFC but should be abandoned altogether in order to encourage more pro-rata renounceable offers to be conducted in an efficient and timely manner.
The emergence of the PAITREO (Pro-rata Accelerated Institutional with Tradeable Retail Entitlement Offer) –(refer ownership-matters-research-paper/media/Ownership-Matters-research-paper.pdf” target=”_blank”>ownership-matters-research-paper) – has balanced the desire for speed of raising with fairness and should be further encouraged. However, over the past two years the likes of ANZ, Slater and Gordon and Cardno have failed to follow the lead of issuers like JB Hi Fi, Origin, NAB, CBA and AGL which have conducted PAITREOs when raising capital.
There are still too many selective placements, frequently at a discount to the prevailing share price, which often lack transparency.
As it stands, a company is able to place 15% of its issued capital to a non-shareholder without shareholder approval. There is no limit to the discount that can be applied. This would be unthinkable in the UK, which has the world’s most robust culture and regulations respecting pre-emptive rights of owners (refer Pre-emptive Group Guidelines UK: Disapplying Pre-emption Rights).
A notable example of the Australian system from 2013 was when Alumina placed 15% of it issued capital to the state-owned Chinese investor CITIC, raising $452 million at $1.235 a share. The independent shareholders did not get a say in the transaction which introduced CITIC as the largest shareholder, putting it in the box seat to block any future third party bid for Alumina.
The rules are even looser for companies outside the ASX300 which are able to place up to 25% of the company’s capital provided there has been prior shareholder approval for the additional 10%. However, some of the same major shareholders pre-approving this additional 10% are also likely to benefit from the change.
Another problem with the current system relates to the disclosure of under-writing fees, which appear excessive for the risk being taken. The full costs of capital raising are often not explicitly disclosed (refer ACSI discussion paper: Underwriting of rights issues) and it was disturbing to see costs actually rise (refer ownership-matters-research-paper) in the post-GFC period.
Shorter time-frames, the removal of prospectus requirements and encouragement of directors to market test pricing, potentially from alternative providers to conventional investment banks, are all avenues through which value leakage from capital raisings could be reduced.
To make capital raisings with pre-emptive rights more attractive, all requirements to produce prospectuses for entitlement offers should be abandoned, instead relying on the continuous disclosure regime and cleansing notices to inform investors.
Disclosure of the participants of capital raisings done in a non-pro rata basis after the allocations have been made.
Increased disclosure of capital raising fees to encourage reduced costs. Total fees to be paid should be disclosed when the raising is first announced, and also captured later in the appendix 3B ASX announcement (including for placements).
Prior shareholder approval for placements required where there are top-up rights, allocations of more than 10% of a company to a single shareholder or allocations to existing members already holding more than 20% of an issuer.
Abolish the additional 10% placement capacity for companies outside the ASX300.
The ASX listing rules should require directors to contemporaneously announce these details to the market when unveiling a capital raising:
- “If not, why not” on a renounceable rights issue
- Total fees to be paid to third parties under the proposed offer
- The basis of pricing;
- Any related party involvement and whether or not this was done at arms length
- Allocation policy and specifically whether existing members will be given priority
Chinese state-owned investor CITIC was placed 15% of Alumina at a marginal premium of $1.235 in 2014 when it would have been preferable for CITIC to buy these shares on market and then have a pro-rata raising to all shareholders.
$350 million non-renounceable 5-for-13 entitlement offer at 38c in 2013 saw retail investors squeezed out of 3.88% of the company, which was picked up by the 3 foreign airline shareholders (Singapore Airlines, Etihad and Air New Zealand) which under-wrote the offer.
Executive chairman and largest shareholder Gerry Harvey personally under-wrote a heavily discounted a 1-for-25 $120.7 million non-renounceable entitlement offer at $2.50 in late 2014 when the stock was trading at $3.71.
Almost 70% of the company’s 12,000 retail shareholders declined to take up the offer and weren’t compensated for their rights. This could not have happened with a PAITREO.
ASX capital raising result announcement
Private equity firm Crescent Capital initiated two heavily discounted entitlement offers after securing board control in 2015. The first was a 1-for-2.75 offer at $1 to raise $78 million when the stock was previously trading at $2.35. Crescent partially under-wrote the offer and lifted its stake from 39% to 43%.
The second was a non-renounceable 1-for-1.07 offer at 40c which Crescent again partially under-wrote, lifting its voting stake to 46.71% (see change of interest announcement here). Non-participating shareholders have not been compensated for their rights.