Your guide to retail share offers

Australian companies are recapitalising en masse. After years of extolling the virtues of an efficient (read ‘debt-laden’) balance sheet, the global financial crisis has encouraged a rapid rethink. The past few months (in 2009) have seen a large number of equity raisings as companies try to reweight their balance sheets with more equity and less debt.

In 60 seconds flat, three of our team managed to recall equity raisings over the past few months by the following companies – Wesfarmers, IAG, Commonwealth Bank, Suncorp, Westpac, Tabcorp, Lend Lease, Qantas, Fairfax, BlueScope Steel, Bank of Queensland, Newcrest, Macquarie Office Trust and General Property Trust. There have been many more.

From a retail investor’s point of view, there are two main ways a company will knock on your door asking for cash. The first is via a share purchase plan (SPP), which is easily identifiable because you’ll be offered a dollar amount of shares. Typically, you’ll get to choose between buying $1,000, $3,000 or $5,000 (and now even up to $15,000) worth of shares at a fixed price, typically a discount to the share price at the time the deal was announced. The same offer is made to all retail shareholders, whether they own 100 shares or 1% of the company.

Make the most of your rights

The second type of equity raising is a rights issue. These take two forms, renounceable and non-renounceable (the latter now commonly referred to as a ‘retail entitlement offer’). Rights issues are pro-rata, so the more shares you own, the more you get offered (making them fairer in our opinion). For example, Wesfarmers recently had a retail entitlement offer of three-for-seven – meaning if you owned 700 shares, you had the opportunity to buy 300 more – at $13.50.

Both rights issues and share purchase plans are usually issued at a discount to recent market prices, to tempt you to invest. With renounceable rights issues, if you don’t wish to participate you have the opportunity to sell your rights on the market and receive value in exchange for giving that discount to someone else. And if you fail to act, companies will now usually sell that right on your behalf at the end of the offer period, and send you a cheque. With share purchase plans and non-renounceable retail entitlement offers, however, it’s a take it or leave it proposition.

Deciding whether to invest more money on a long-term basis, or pass up entirely, is no different from deciding whether to buy the shares on the open market. If it’s a good company, with decent management and a cheap stock price compared with a conservative estimate of intrinsic value, it probably makes sense. If the stock is overpriced, it doesn’t (if this is the case, you might want to think about the rest of your holding). And if the stock is fairly priced, the decision is more line-ball. We’d suggest using our stock recommendations as a guide.

With many companies currently after your cash, though, it pays to be choosey. As we’ve noted elsewhere, what are the odds that the very best option for your money today is the offer document that just landed in your letterbox?

As should regularly happen, let’s say that you come to the conclusion that a long–term investment in this stock isn't the best option for your spare dollars today. Don't throw out that offer document just yet.

Don’t miss your ‘free lunch’

If it’s a renounceable rights issue, check to see whether those rights will be sold on your behalf at the end of the rights period. Because if not, you’ll want to make sure you sell the rights on the market before the offer period lapses – call your broker if you're not sure what this involves.

If, however, you’re dealing with a share purchase plan or non-renounceable retail entitlement offer, then you might want to consider engaging in a little arbitrage. French for ‘free money’ (sort of), arbitrage in the traditional sense is an opportunity for risk free profit.

Let’s assume you were a Wesfarmers shareholder when it went into a trading halt on 22 January 2009. If so, you were subsequently invited to participate in the three-for-seven non-renounceable retail entitlement offer. If you owned 3,500 shares, you were offered the chance to buy 1,500 new shares (3,500 divided by seven, times three) at $13.50 each.

After quite some thought, and perhaps a perusal of Intelligent Investor’s recent Wesfarmers reviews, you decided that you didn’t want to commit an additional $20,250 for long-term investment. But you effectively held an option to buy those additional shares up until the closing date on 23 February 2009, which could be valuable. Perhaps you could sell 1,500 of your old shares at a price high enough to guarantee a profit, safe in the knowledge you could buy them all back at $13.50 through the offer.

When considering whether it’s an arbitrage opportunity, don’t forget the effect of dividends. In this case, Wesfarmers had declared a 50 cent fully franked dividend that was due to go ex-dividend on 24 February. According to the offer document, though, the new shares weren’t entitled to the dividend, unlike the shares you’re considering selling. To account for this, you’d probably only be interested in selling at a price that compensates for the dividend and the franking credits. A 50-cent fully franked dividend grosses up to 71 cents (50 cents/(100%-30%)).

Calculate the profit

So, you’re unlikely to get excited unless you could sell your shares for in excess of $14.21 ($13.50 $0.71). On the first day out of trading halt, 27 January, Wesfarmers’ share price closed at $16.40. The lowest closing price during the offer period was $15.00 on 5 February and it was over $17 by the time the offer closed.

Let’s say you decided to sell your 1,500 shares towards the end of the day on 29 January for $15.82 (incidentally, this is close to the average trading price over the whole month, so a fairly typical example). This sale generated $23,730. After deducting $100 for brokerage, setting aside $20,250 to pay for the new shares, and $1,065 for the franked dividend forgone (1,500 times $0.71), you’re left with a pre-tax, risk-free profit of $2,315.

Unfortunately, this isn’t the whole story. We should be using post-tax numbers, taking into account capital gains or losses on the share sale. But every instance is different and it’s difficult to illustrate. As a general rule, for those who bought their shares in recent years at prices far exceeding today’s, then the arbitrage is at least as good as illustrated above, with the added benefit of locking in a capital loss. For those who’ve owned Wesfarmers since the 1990s and would therefore be making a capital gain, the arbitrage may be more marginal, or even loss-making.

Also, calling it a ‘risk free’ profit might be misleading. In our opinion, taking advantage of such arbitrage opportunities is more about avoiding a guaranteed, no-upside loss, caused by dilution. But that’s a discussion for a future Investor’s College.