More than any other factor, it was Australia’s seven million mum and dad shareholders, plus their inheritance-focused children, who won Scott Morrison the 2019 election – courtesy of Bill Shorten’s overly ambitious franking credits policy. And how do Morrison and his Treasurer Josh Frydenberg repay those faithful shareholders for their support?
Last week they used the cover of the Covid-19 crisis to deliver totally unnecessary changes to Australia’s capital raising rules that will only serve to enrich Wall Street’s elite investment bankers whilst monumentally shafting ordinary small shareholders.
And all those in on this giggle can’t say we haven’t seen this movie before. During the GFC, ASX listed companies collectively raised an emergency $100 billion in record time, diluting small shareholders out of more than $10 billion in value and enriching those same investment bankers with an easy $2 billion in fees. See this report by Ownership Matters.
The corporate regulator ASIC, the monopoly markets provider ASX – and a small group of top end of town corporate lawyers associated with investment banks and Australia’s inbred director’s club – conspired with Josh Frydenberg to rush through a series of changes last Tuesday. There was no consultation with anybody representing millions of Australia’s small shareholders.
The worst of these changes is lifting the annual limit on shares which can be placed with non-shareholders without shareholder approval in any 12 month period from 15% to 25%. As Terry McCrann explained in an excoriating column in The Weekend Australian, the change is actually much worse than this because the old requirement that you can’t do a pro-rata share issue greater than a 1-for-1 without shareholder approval has now been changed to a 2-for-1.
And if a company proposes a two-for-one twinned with a 25% selective placement, they can include the new shares issued in the two-for-one in the 25% placement cap figure – meaning that said company can actually place 75% of the company’s shares on the night before the raising is announced to non-shareholders.
Cochlear a case in point
While McCrann’s piece didn’t point to any of the many egregious capital raising examples we’ve already seen over the past fortnight, Fairfax’s Sarah Danckert made a good fist on Saturday of explaining the rort by pointing to the rip-off perpetrated on the 34,000 small shareholders in the bionic ear giant Cochlear.
It goes like this. Cochlear shares were foolishly floated off by the old Pacific Dunlop at $2.90 a share in 1995 and soared all the way to a record high of more than $234 in January this year, when it was valued by the market at $13.53 billion. With barely $300 million in debt on its balance sheet, Cochlear was the last company you’d expect to launch an emergency capital raising, but ear implants are an elective surgery and elective surgeries are being cancelled the world over to focus hospital resources on treating Covid-19 patients.
In line with the broader market, Cochlear shares retreated rapidly to close at $168 on Monday, March 23. The next morning, Cochlear announced a totally unexpected $800 million selective placement at the fixed price of $140 a share, a 16.7% discount to the last traded price.
Retail shareholders were promised a $50 million Share Purchase Plan (SPP) where each could buy up to $30,000 new shares. JP Morgan, a Wall Street investment bank valued by the market at $US258 billion, kindly agreed to underwrite the Cochlear offer for a $20 million fee, meaning that if fund managers from all over the world refused to bite, it would write a cheque for $800 million to take a 9% stake in Australia’s most famous medical company – 57.1 million new shares out of the expanded total of 63.54 million on issue.
JP Morgan was only “on risk” for about 24 hours because the placement was “accelerated” meaning that Cochlear could literally launch a fire sale of cheap shares after lodging nothing more than this powerpoint presentation with the ASX at 8.30am on a Tuesday morning.
By the time Wednesday morning rolled around, Cochlear announced that JP Morgan had been swamped by demand from their mates and associates in this bargain basement fire sale, so they all agreed to sell off even more of the shop, lifting the placement to $880 million.
And did this mean an extra $80 million in cheap shares would be offered to the 34,000 loyal Cochlear shareholders?
Not on your nelly, the SPP is still being capped at just $50 million, a miserable 5.4% of the total $930 million raising. If all 34,000 shareholders apply for the maximum $30,000 new shares in the SPP, that will total more than $1 billion in applications and would lead to a massive scale back.
The majority of Cochlear’s shareholders (of which I’m one) won’t even bother applying, partly because Cochlear won’t even pay interest on the monies they bank and then refund. If you do the maths, the Cochlear board has only set aside enough funds to satisfy 1666 shareholders applying for the full $30,000 SPP, that’s just 4.9% of all shareholders.
Foreign fund managers given six times more stock than all retail shareholders
Meanwhile, an elite bunch of fund managers in London behind the privately owned partnership called Veritas Asset Management, was allocated a staggering $304.5 million of the $880 million placement. And with Cochlear shares closing at $182.02 on Friday night, Veritas is already enjoying a paper profit of $91.4 million on these 2.175 million shares, which equated to 34% of the 6.286 million new shares issued in the placement.
We only know this because Veritas launched a buying splurge shortly before and after the placement to finish up with a 5.57% stake which was above the 5% substantial shareholder rule in Australia and was therefore disclosed to the ASX on April 2. As of Friday night, Veritas owned $650 million worth of Cochlear shares, more than $100 million of which is pure profit.
If the placement price was set through a competitive auction (known as a book-build in equity markets parlance) rather than at the fixed discount price of $140, the discount would no doubt have been less.
But that wasn’t in the interest of JP Morgan which wanted to minimise its risk and maximise the profits pocketed by favoured clients such as Veritas.
This is where the board failed in its duty to look after existing shareholders. Cochlear is chaired by Rick Holliday-Smith, who also doubles as the long-serving chairman of the ASX itself. The proxy advisory firm Ownership Matters summarised what was wrong with the capital raising changes agreed to by the ASX in this article.
Door open for foreign raiders
One of the impacts will be foreign predators gaining larger stakes in distressed ASX listed companies at a cheap price and we’ve already seen that play out at two companies.
Firstly, there was an emergency $167 million raising from debt-laden outdoor advertising company oOH!media, which comprised a $39 million placement at 53c plus a 1-for-1 entitlement offer for existing shareholders at the same price.
The stock had last traded at 84c before the offer was launched and the company returned to the common GFC model of raising money with both a placement to whoever the under-writers can find, plus an entitlement offer for existing shareholders which was non-renounceable.
This means that existing shareholders who don’t participate get no compensation for their rights.
Many companies in this situation allow retail shareholders to apply for extra shares to take up the shortfall left by their colleagues, but in oOH!media’s case applying for “overs” has been banned, meaning that the retail shortfall will be larger and more shares will transfer across to the under-writers.
Overall, oOH!media’s 3400 retail shareholders will be badly diluted as a US private equity firm HMI agreed to under-write part of the retail offer as part of a push to lift its stake from 18% to 25% and take a board seat.
This is almost like a change of control with no premium paid. Shares in oOH!media finished at last week at 61c, meaning the recipients of the $39 million placement shares are currently almost $6 million in front on their investment and those picking up the shortfall on the coming $11 million retail offer will enjoy similar gains.
Webjet fire-sale at ridiculously cheap price
A similar thing happened at travel company Webjet which will end up raising $346 million broken down into 3 components: $115 million in a placement at $1.70, $116 million from an accelerated 1-for-1 institutional entitlement offer at $1.70 and $115 million from the 1-for-1 non-renounceable retail offer.
The discounted pricing was the most offensive element of this offer because Webjet shares last traded at $3.76 before it was suspended and when it resumed trading it finished the week on April 3 at $2.73, a massive 60% premium to the $1.70 placement price.
Foreign private equity firm Bain took a 6% stake for $25m through the discounted placement and could finish up with 16% after committing to take an additional $40m from the retail shortfall. Again, a foreign predator picking up cheap stock from retail investors because of the way the raising was structured.
Webjet started this process with 135.6m shares and ended up placing 67.6 million which was 50% of the pre-raising share capital.
Non- participants in the retail offer will get nothing but participants can apply for “overs” equivalent to 100% of their entitlement, which at least should partly reduce the size of the shortfall but the “overs” component really should have been unlimited.
There are 10,600 Webjet shareholders and because Webjet utilised the new rules, the overall share ownership of retail investors in the company will tumble from 50% to less than 20%, mainly because a foreign private equity firm Bain is attempting to barge in with a 16% stake when they owned nothing before the offer was launched. Capital raisings by debt-laden companies were expected but then there was also some completely unexpected raisings, alongside the $930 million Cochlear offer.
Even financially strong companies are abusing the new system
Perhaps the best example was the data centres company Next DC which first put out a statement talking up how Covid-19 would likely benefit its business model. There was no inkling of any need to raise fresh funds, but then it went bang with a $672 million placement equivalent to 25% of its shares on issue, just one day after the ASX lifted the annual placement limit from 15% to 25%.
Some of the existing institutional shareholders received no stock and the company has not disclosed who it did choose to allocate the new shares.
That’s the problem with placements. It’s a secretive share allocation process.
Once against the pricing was heavily discounted, with the Next DC shares offered at $7.80, a 15% discount to the previous close. If giving away part of the company to non-shareholders, at least there should be some disclosure as to who took the shares.
And why didn’t Next DC just do a pro-rata offer to its existing shareholders?
Kathmandu shafts its biggest shareholder
Sometimes existing shareholders just don’t have the capacity to participate in a rushed capital raising during a crisis and that can see them massively diluted.
That’s exactly what happened to New Zealand entrepreneur Rod Duke whose Briscoe business used to be the largest shareholder in retailer Kathmandu with a 16% stake but couldn’t afford to participate in its emergency capital raising.
Kathmandu is suffering indigestion after paying $350 million in cash for Rip Curl in November last year and has now embarked on an emergency $NZ207 million capital raising comprising a $NZ30 million placement and a $1NZ177m 1.2-for-1 entitlement offer at NZ50c.
However, because the offer wasn’t renounceable, when Briscoe rejected the offer, its shares were just given away to new investors at NZ50c and he was diluted down to just a 6% stake. If the system was fairer, these shares would have been sold off to the highest bidder and Briscoe would have been given some compensation. Sometimes the victims in this system can be big players, it all just comes down to whether you’ve got the spare cash and wit and to support a shot-gun capital raising overnight.
Kathmandu shares finished at 76c on Friday, so whoever picked up the placement shares and the Briscoe shares at just NZ50c is enjoying a very tidy windfall of around 50%. The same thing will happen with the $NZ53 million retail component of the Kathmandu raising which will no doubt finish well short and deliver more cheap shares to the under-writers and their clients.
Once again, Kathmandu’s retail investors aren’t able to apply for any additional shares and the offer is non-renounceable. The biggest losers in Australia’s capital raising system is the retail shareholder who does nothing when presented with an in-the-money offer.
History shows the majority of retail investors don’t act rationally which is why you need boards to protect them with renounceable pro-rata entitlement offers where the non-participants are compensated for their rights.
So, what should happen now?
After soaking up the widespread criticism, the ASX needs to immediately change its rules mandating that capital raisings must be pro-rata and renounceable.
As for placements to non-shareholders, the UK limits them to just 5% of the shares on issue yet we are now allowing 25% a year. It should be immediately wound back to 15% far earlier than the proposed July 31 cut-off date. And when boards do opt for a placement, they should be required to auction the stock off to the highest bidder in a competitive auction, not just sell them at a heavily discounted fixed price which guarantees easy profits for the unknown recipients.
We also need to be told who pocketed the new stock. Finally, companies should also be prepared to try doing a capital raising that is not under- written by overpaid investment bankers, which is exactly how prominent under-writer Macquarie Group does it every time they raise capital for themselves.
Why leak millions to investments banks for taking such a small risk? Investors would have bought the new Cochlear shares whether JP Morgan was being paid $20 million or not. Same with the $15 million leaked to the under-writers of the $672 million Next DC placement. Respect for property rights in Australia’s anything goes capital raising system is sadly missing at the moment and we’re seeing increasingly wild west practices in the middle of a crisis which are ripping off small shareholders.
If the Morrison government cares about looking after the interests of their beloved franking credits army of small shareholders, they need to step in and stop the big end of town rip-offs immediately. It has only been a week under the new system so far and the experience has already been awful.
It’s time to reverse these changes before any more damage is done as we batten down the hatches for a flood of new capital raisings to get Australian companies through the Covid-19 crisis.