The Leighton temptation

PORTFOLIO POINT: Leighton’s discounted share offer is structured so that investors can profit without participating.

Good news has been in short supply at Leighton Holdings recently following the departure of a “superstar” chief executive and a shock earnings downgrade.

But shareholders should be pleased that a capital raising designed to shore up the construction company’s balance sheet is being conducted in a fashion that allows all shareholders to benefit – whether they decide to take up their entitlement or not.

First, the background. After chief “rainmaker” Wal King left in late 2010, after 23 years in the top job, a series of problems emerged with its operations here and abroad that led to a forecast profit of $480 million being revised down to a loss of $427 million.

To bridge the gap of this rather impressive shortfall of close to $1 billion, Leighton has gone to the markets to raise $757 million with an offer by which shareholders can buy one share for $22.50 for every nine they own.

The offer is structured as a renounceable entitlement offer, providing investors with the option to either buy additional shares, or have their entitlement sold on their behalf at the conclusion of the offer period. Shareholders have until May 6 to apply for additional shares; the book-build for those entitlements not taken up by investors will be conducted on May 11.

The difficulty for investors is gauging the degree of uncertainty that surrounds the company.

In addition to questions about King’s successor and problems with individual projects like the Brisbane airport link, Leighton has cancelled its final dividend for the year. What’s more, its majority owner, the German firm Hochtief, is itself the target of a hostile takeover from Spanish construction company ACS.

Another issue is that over the past 10 years Leighton has provided investors with a total return (dividends and capital growth) of 18% a year, and 13.1% over five years, in both cases well above the market average return (returns to April 21, 2011). These returns might mean that investors already have more than enough exposure to the company, leading them to be less inclined to add further shares to their portfolio.

The $22.50 offer price is only about 10% below the current share price. This raises the possibility that shares bought for $22.50 in the entitlement offer might trade below this price – although in this case “'retail”’ investors do have the benefit of seeing what decisions institutions made given that the institutional offer is already completed with 98% of institutional investors buying shares at $22.50 or sold to other investors in a bookbuild at $24.50.

The options

Retail shareholders considering the Leighton’s renounceable entitlement offer have three options:

• Apply for additional shares at $22.50 by May 6. For investors who want to increase their exposure to Leighton, this is likely to be the option they’ll choose.

• Do nothing. This means you are effectively renouncing the entitlement and the shares you are entitled to will be sold in a bookbuild. If those shares are sold at a premium to $22.50, you will receive this premium. For example, if the shares are sold for $25, investors will receive $2.50 for each share they were entitled to. The shares renounced by institutions were sold at a price of $24.50, so institutions received $2 per share.

• Put together a mix of the first two options that suits their view of the company, their portfolio and personal circumstances.

Shareholders in Origin recently had four options in the renounceable rights issue offered by that company and it is interesting to look back on how those investors have fared (see Origin shows how).

Investors who choose to participate are probably feeling quite pleased with themselves after last week when the company announced a deal with Sinopec to take a strategic stake in its coal seam gas project alongside a significant off-take agreement. At the close of business today those shares were trading for $16.87 or a gain of 29.7%.

Those investors who did nothing (effectively renounced their entitlement) had their rights sold on their behalf at the end of the offer period received $2.80 for every share that they owned. This ended up being an attractive price, however Origin’s offer also included rights that were traded on the market under the code ORGR. These rights reached a peak of $3.57 on April 4 and investors who sold into that price may have still done quite well after accounting for brokerage.

-The timeline
Date	Event
Tuesday 19 April	Retail offer opens
Friday May 6	Retail offer closes
Wednesday May 11	Retail shortfall bookbuild
Thursday May 12	Retail shortfall bookbuild closes
Tuesday May 17	Settlement of retail shares
Wednesday May 18	Allotment of retail shares
Thursday May 19	Trading in retail shares commences

There is no doubt that the circumstances of investors will dictate how they participate in the Leighton’s offer. For those investors looking to increase their exposure to Leighton Holdings this would appear to be a reasonable opportunity to do this. There are, however, likely to be many investors who are a bit more reticent to do so.

The profit warning, management changes, ownership issues, and relatively thin discount of the $22.50 offer price to the current share price of $24.80 might see investors turn to the second option they have of doing nothing, and having their rights sold on their behalf.

After 10 years of strong returns many investors might find their portfolios uncomfortably overweight. For investors who don’t want to participate it is a positive that Leighton has structured the offer so that they can have their shares sold for them into the marketplace and still receive a cash benefit if the shares are sold for more than the $22.50 offer price.

Scott Francis, an independent financial adviser based in Brisbane, owns shares in Leighton Holdings and will be renouncing his rights to this offer.