In general we are sceptical about capital raisings in Australia, with the ‘private placement’ structure heavily tilted towards investment banks, broking houses (and their clients) and pension funds able to take on outsized allocations.
That being said, it’s not often that the ‘world is on sale’ like this and there are no doubt some high-quality businesses in need of capital for a short period of time. On the basis that you remain comfortable holding the stock (i.e. you haven’t retained it for emotional reason) and that it is a high quality-business, our advice is to take up as much as possible with one standard rule: this discount must be at least 10% to the share price nearing the close of the offer.
All capital raisings are based on the share price pre-offer, but the share price tends to move immediately after any announcement, typically down, hence it is important you aren’t paying more for your shares than simply buying them on market. The only way to protect yourself from this is to wait until just a few days before the close before making your payment. The 10% rule is a little arbitrary, but given the way markets are moving lately, it means you have the potential to sell your additional holding at a profit once the shares are issued; with COH being an excellent recent example.
Historically, capital raisings have been used for positive returns, to fund acquisitions, expand operations or fund capital investment. These are the real, but often forgotten reasons for the existence of sharemarkets around the world, to provide business with capital to deploy and grow. In 2020, however, the reasons for capital are more around survival, so investors need to be aware of both the purpose of the capital and the outlook for any company they hold.
Some important considerations include looking at the earnings profile of a business, has it been growing earnings and or more importantly revenue over the last five years, or is it in a low margin, highly competitive sector. Further, investors need to be aware of the company’s cash flow position.
- Are they converting profit to cash and at what rate?
- How much money is the company burning on a monthly or quarterly basis whilst sitting idle amid COVID-19 restrictions? Flight Centre or 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?
These are the situations, not necessarily the companies, we would seek to avoid. Those who investors should support are the ones that have high-quality businesses with a strong growth profile but due to these unforeseen circumstances need capital to stave off their creditors, or to keep the lights on should the implications last for longer than the predicted 6 months. In many cases, the raising of capital is simply to ensure debt covenants to bankers are not breached and can be triggers for a strong recovery.
An interesting case study is QBE, which has announced another capital raising this week, following similar raisings in 2012 and 2014. The company has a track record, under various management teams, of either growing too quickly or not carrying sufficient capital and thus being required to go back to investors to solidify their balance sheets on a regular basis. Generally, there is no problem with these raisings, so long as they are resulting in the business growing or becoming stronger and your new shares more valuable. In QBE’s case, their earnings have actually fallen since 2014 and grown just 10% in total since the raising in 2012.