Riding the next capital raising wave

The forthcoming results season will show how COVID-19 has hit corporate Australia and capital raisings will inevitably follow.

Right now we are in the eye of the capital raising storm.

Listed entities needing COVID-19 equity came to market with great success in the first half of the year. Despite some criticisms, the vast majority of large holders followed their money into these raisings. Smaller holders took advantage of the discounts on offer and there appeared to be an almost endless stream of cash from other sources supporting these “asks”.

The forthcoming results season will show how COVID-19 has hit corporate Australia. Capital raisings will inevitably follow.

So it is a good time to pause and think about a key learning of that first wave.

It is crystal clear that Australia has the best regulatory settings for equity capital raisings in the world. The statistics bear that out – Australia accounted for US$22 billion ($31.7 billion) of the capital raised globally in the first half of the year and led the rebound in global equity issuances from the beginning of the pandemic until early May.

An astounding and disproportionate result on any measure, especially as Australia represents only 2 per cent of the Morgan Stanley Capital Index. Of course, size alone is not the true measure of success. Market integrity and positive sentiment are also important factors.

It is too early to tell for the raisings so far, but the experience during and since the 2008 financial crisis provides validation. Very few raisings have been suspect and typically those who participated prospered. Meanwhile, Australian listed entities have weathered these storms well.

However, some small institutional holders and high net worth individuals have felt left out in the cold. They are too small to get the “institutional tranche” call when placement bookbuilds are arranged at speed, but too large to get their pro rata share from the share purchase plan (SPP) that follows (SPPs cap out at a $30,000 investment).

Issuers and underwriters have done their best to include those small holders through retail broker syndicates, but this can sometimes be hit and miss. And while a rights issue would give those left in the cold that pro rata opportunity, rights issues pose timing issues for underwriters seeking to get “off risk” quickly, liability disadvantages for issuers and can be less advantageous to small holders than an SPP.

“It is crystal clear that Australia has the best regulatory settings for equity capital raisings in the world.”

Four possible fixes

What is the fix? Well there are four possibilities (maybe in combination).

First, change Australian securities laws so that a compliant listed entity can rely on its continuous disclosure to issue without a prospectus to anyone provided they give preference to their existing holders. Currently, they can do this only for a rights issue, a placement to institutional investors or an SPP.

There is no real underlying policy reason for those limitations. Our laws just evolved that way. COVID-19 has shown that the placement/SPP combination is by far the most effective route to market in uncertain times. However, because it leaves these “gap” holders stranded, law reform to facilitate structure-neutral issues that all investors could participate in would solve the problem immediately.

The second alternative is to shorten the rights issue offer period so that entities can get access to underwritten funds faster and at a better discount. With electronic access to corporate communications becoming more prevalent every year, surely it is now time to accept that rights issues should be able to be done and dusted within ten business days.

Third, allow rights issues to build in the same protections for retail holders that are embedded in most recent SPPs. Namely, that the price that retail holders transact at is the lower of the institutional price and a discount to the five day volume-weighted price of the stock leading up to close of the offer (usually 2.5 per cent).

That would give boards the comfort that there would always be up-front value in the retail tranche. Would that create a short-sellers’ paradise? No more than in the SPP environment.

Finally, find ways pre-emptively to “onboard” the “gap” investors through retail brokers in advance of capital raisings on a standing basis (i.e. at a time when no particular capital raising is being contemplated). We would not expect them necessarily to participate in the upfront bookbuild, but at least this would provide flexibility to do so.

ASX was planning to sunset its temporary emergency capital raising relief at the end of this month but given the recent issues in Victoria that may be revisited. Even so, the fairness and pro rata debate has become something of a religion and the initiatives above will help to solve them for the next wave and the ripples which follow.