There has been some discussion in the media in recent weeks comparing different capital raising structures as if some are inherently better than others.
In fact the “best” structure will depend on a range of contextual factors – whether the raising is for balance sheet repair, growth/acquisition or to provide working capital; whether the issuer is in control of the timetable; the profile of the share register (institutional or retail based); whether the offer should be underwritten, and transaction cost.
The positioning around which approach is fairer misses that point. Fairer to whom?
Section 47 of the Companies Act recognises that complexity by requiring directors to exercise judgement and to certify what they consider to be fair and reasonable to both the company and existing shareholders. For issues at a more than 15% discount, the listing rules also require directors to certify the price is fair to those not participating.
A Chapman Tripp analysis of equity raisings in the New Zealand market during 2020 to the end of March this year found that a placement and share purchase plan (SPP) combination was the most popular option, accounting for more than half of the sample (27 of 46 transactions).
The order of use from there was: placements and Accelerated Non-Renounceable Rights Issue Offers (ANREOs) on seven; traditional rights issues on six, and, on two each: simple placements; placements with traditional rights issues; and Accelerated Renounceable Rights Issues (AREOs).
In Chapman Tripp’s experience, boards grapple over the trade-offs involved in each of these options. There is a lot to think about.
The SPP rules require any scaling to be pro rata to holdings at record date or closing date, to reduce the risk of those with small holdings gaming an issue by applying for large allocations. The New Zealand “same class” offer statutory rules make it simple to extend placements to retail investors with the result that retail firms and platforms such as Sharesies are frequently included in placement book builds.
Most placement/SPPs have been priced at a “single digit” discount. By contrast, recent AREOs have been discounted at least 13%-16% to incentivise participation.
The secret charm of the ANREO is that it is easier to secure sub-underwriting support and is dilutive only to those who choose not to participate. Other structures seek to provide value to non-participants through a “shortfall bookbuild” on their behalf. Although some fairly question why, if a company is trying to plug a gap in its balance sheet, disloyal shareholders should get any value for their rights.
ANREOs, or “JUMBOs” as they are sometimes called, are frequently used in Australia to part-fund large acquisitions and were used for the same purpose in New Zealand in 2007/2008. The discount borne by those who elect to be non-participants in an ANREO should be less than that required for renounceable offers to reflect more uncertainty in a renounceable offer on the size of the shortfall and market conditions over the longer offer period, and thus the risk-position for a sub-underwriter to cover.
The NZX listing rules contain some inconsistencies in the treatment of structural options:
- AREOs and SPPs can be issued with an accelerated “Record Date”, but “traditional” rights issues require a special waiver from NZ RegCo to accelerate the timetable
- SPPs often provide price downside protection for retail investors but – again – AREOs require a special waiver to do so. In volatile markets, the lack of downside protection can create real disadvantage for retail shareholders and, while longer timetables give investors more time to respond, they come at higher underwriting cost due to longer market risk periods.
Value in rights trading or a shortfall bookbuild can be illusory, especially if offer terms allow shareholders to oversubscribe for more than their “rights” – which explains why only two of seven traditional rights issues in the last two years had rights quoted, or any shortfall premium has been modest compared to the economic dilution those shareholders not participating experienced.
The “shortfall premium” on an AREO will often be materially different for institutions and retail – as occurred in the MOVE transaction, in that case to the detriment of founder shareholders, but more often to the detriment of retail investors.
Some improvements to the rules
NZX plans to review its capital raising rules in 2023 but we think some changes should be made now – for example, allowing downside protection in AREOs, and taking some ‘lazy’ days out of the prescribed timetables. That might go some way to tilt some transaction choices back in favour of renounceable issues.
The NZ$15,000 cap on SPP issues per beneficial owner should also be more closely aligned to the Australian cap of AU$30,000. Alternatively the recent market practice of using the placement rule to lift the SPP cap to NZ$50,000 each could be given the status of a rule.
Clearly the use of an ANREO or JUMBO is a controversial topic that warrants deeper consultation before they are permitted as a matter of course, rather than by waiver. In our view, it will be a rare occasion when an ANREO can be readily justified, but that does not mean they should be off the table entirely.
But carefully crafted protective rules, such as caps on the offer ratio or price discount, and oversubscription scaling rules, can remove some of the rougher features, and such design elements were included as standard features in the initial COVID-19 emergency capital response period in mid 2020.