Why capital-raisings anger long-term shareholders

Long-term equity holders have accused Australian company directors of being unaware of the effects of capital raisings on existing shareholders.

The comments came yesterday at a heated panel discussion on the ethics of capital raisings held by institutional governance consultants, Ownership Matters.

“Boards don’t understand the problem,” said Graham Lennon, a director at Dimensional Fund Management. “And they don’t supervise the investment banks.”

Australian companies have raised $19.2 billion in capital so far this financial year. Most recently, Bank of Queensland conducted a $450 million capital raising that angered some shareholders after they were heavily diluted.

Disgruntled owners can pose difficulties for companies by voting to sack company directors when they are up for election.

“We haven’t got a lot of leverage but we will apply it where we can,” Lennon said.

Adding pressure is ASIC. Deputy chair Belinda Gibson flagged yesterday that the regulator was taking an interest in capital raisings, warning it may seek to toughen laws if shareholders are repeatedly disadvantaged.

Typically companies appoint large investment banks to conduct their capital raisings. During and since the global financial crisis, banks have increasingly raised capital through placements, where shares are offered to sophisticated or professional investors (often hedge funds and other bank clients) at a discount. This strategy, which can be completed quickly – in days or even hours – dilutes the shares of shareholders who do not participate. And it can harm them again by pushing down the market price of the shares.

This can leave long-term owners fuming. But when they contact company chairmen, they’re often met with a puzzled response.

“Generally the chairman is surprised we’re unhappy,” said Simon Marais of Allan Gray. “They say it’s general market practice.”

Company management sign off the process, says Guy Foster, head of equity capital markets at Bank of America Merrill Lynch. He has never conducted a capital-raising where the structure was not signed off. However, he acknowledged sometimes companies won’t have understood the full implications of the type of capital-raising being carried out for them.

“Sometimes we’ll have to go back and explain ourselves, but we’ve always consulted with the company [prior to the raising],” he said.

All the investors on the panel expressed a wish to see further transparency. Marais went further: he wants current shareholders to have the first offer to increase their holdings in many capital-raising instances.

But Foster said this isn’t realistic, and is unfair to new shareholders. He said current shareholders typically waited until “five minutes before the book closes” to express an interest, and even if they did, new shareholders weren’t going to be happy receiving the dregs of a raising.

If they’re only allocated shares in the event of an unattractive or “sloppy deal”, he said, “fund managers won’t bother”.

One suggested solution was developed by Merrill Lynch last year in its capital-raising for Origin Energy and since used in a Goodman Fielder capital-raising. The PAITREO (pro-rata accelerated institutional, tradeable retail entitlement offer) structure doesn’t harm existing owners while still providing an attractive offer for institutional investors. All existing shareholders and invited institutional investors participate in an original offer, and the price for any unsold equity is determined by book build. For two weeks after this, individual (retail) shareholders are able to trade their rights to participate, and so are compensated even if they don’t buy any more shares.

However, the award-winning PAITREO structure has not been widely used since its unveiling this time last year, possibly because it is more expensive.

Foster, while stressing the benefits of the PAITREO structure, cautioned against a one-size-fits-all approach to capital raisings.

High fees, lack of competition worry shareholders

High fees charged by banks across the board for capital raisings also provoked contention on the panel.

Marais said it was “extraordinary that all banks price all deals the same”, and asked why there wasn’t more bidding for work between them, which would lower their fees.

But why would they do that, interjected University of Technology Sydney’s Jack Gray from the floor. “There’s no institutional collective pressure for them to change,” he said. “It’s a cartel – why would they?”

He added that given how hard it was for companies to judge the quality of the service they received from the banks, economic theory would have the price of such raisings go down. But the lack of competition meant it went up instead, and Gray accused the banks of pricing themselves highly to make their services seem more valuable.

“I think our fees are quite reasonable,” said Foster.

Prices are not as high for companies in Australia as they are in the United States and the United Kingdom, he added. He said it was because there were more banks in the Australian market which carried out such raisings.

“The discounts [on equity offered in placements] are lower here, as are the fees,” he said. “[In] Australian capital markets discounts are frowned upon.”