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Why investors should care about fundraises – placings and rights issues

Equity Analyst, Sophie Lund-Yates, takes a look at how companies can raise extra money and what it means for shareholders.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The financial crisis served as a stark reminder for lots of companies. The key lesson? Only cash can keep you afloat.

Lots of companies heard those lessons loud and clear. Balance sheets are in much better shape than before the last crisis. However, the disruption caused by coronavirus means we’re seeing a lot of companies trying to raise extra cash.

When a company trades on a stock market, a common way to raise extra funds is through a placing or a rights issue. Both involve issuing new shares.

Placings and rights issues aren’t uncommon, but the sheer number of fundraises we’re seeing at the moment is exceptional. Between the start of March and early June, 201 companies around the world issued $50m or more of new equity. They’ve raised in excess of $67bn.

What are placings and rights issues?

A placing is when a company creates and sells (issues) new shares, usually to a small number of institutional investors. This can be a convenient and relatively inexpensive way to raise a lot of money.

Alternatively companies can raise money through a rights issue. This is similar to a placing, but it offers new shares to existing shareholders based on how much they hold already. The new shares are usually offered at a discount to the current share price, and taking up your rights is optional – you can usually sell them on the open market instead.

How will fundraises affect my investment?

The biggest factor to consider when a company issues new shares is that it’s dilutive. Think about it like cutting a cake into more slices, leaving existing investors with a smaller piece.

However, it’s important to remember that rights issues are based on the number of shares investors already hold. For those that take up the issue, their proportion of shares held and their voting rights aren’t affected. Of course, for investors that choose not to take up their rights, they will see their overall proportion of ownership fall.

In placings the dilution is unavoidable. Have a look at the table below. The company has 100 shares, and 100 investors hold 1 share each. They each own 1% of the company.

However, if the company decided to issue 50 more shares and 50 new investors were to buy these, the original shareholders will see both their voting rights and proportion of shares held fall.

Number of shares 100 150
Number of original investors 100 100
Percentage of company owned 1% 0.67%

In the end this affects earnings per share (EPS). This is calculated by dividing a company’s profits by the number of shares in circulation. EPS is a major factor shareholders and analysts will look at on a regular basis, alongside profit numbers.

So are fundraises good or bad?

Deciding whether or not EPS dilution is worth it comes down to why a company decides to fundraise in the first place.

If it looks like a placing is being done under pressure, this could be a bad sign. This could happen when a company has been struggling and needs extra funds to keep the lights on, rather than to invest in an opportunity. A recent example of this was with retail property company Intu, which was forced to abandon its placing because there wasn’t enough interest from investors. The company subsequently fell into administration a few weeks later.

This is of course a very extreme example. A successful placing at a struggling company will ultimately strengthen the balance sheet and could see it prosper in the future. But investors should stop and think if an equity raise is ringing alarm bells, and if the long term prospects of the company are still looking bright.

Something else to keep an eye on is the price companies are able to get for their new shares. Another warning sign could be if the company undertakes a placing, but is forced to offer new shares at a large discount to the current share price.

The other side of the coin

The flip side of this scenario is opportunistic investment. A company might decide it wants to embark on a new venture, but that it requires new capital to make that happen. We saw this last year when Marks & Spencer Group asked existing shareholders for money to pay for the joint retail venture with Ocado, for example.

This year Ocado itself has asked investors to stump up to allow it to capitalise on the huge uptick in demand for online shopping caused by coronavirus.

It’s up to shareholders to decide if they’re supportive of this kind of situation, and if they agree with the investment opportunities the company is pursuing. But these are better conditions to be raising money under than because the business is under financial stress.

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What about rights issues?

It’s a bit different when it comes to rights issues because of their voluntary nature and the fact it’s a direct appeal to existing shareholders.

Arguably if a shareholder isn’t supportive of the reasons behind a rights issue and doesn’t intend to partake, there should be wider questions about if the investment is right for you. If you’re not prepared to buy extra shares at a discounted price it could signal that you don’t agree with the company’s strategy or aren’t convinced by its long term prospects.

What investors should take away

Placings and rights issues are likely going to continue being a prominent theme in the months to come. But it’s important to take the time to understand why a company they hold shares in decides to raise extra funds.

If a company comes to investors cap in hand under duress, it might be time to re-evaluate its long term prospects. However, the current disruption has also generated opportunities, and it’s often a good sign when management decides to grasp the nettle and chase these.

Sometimes fundraises can be a case of short-term pain, in the form of EPS dilution, in the hope that this will translate to longer-term gain. As ever, there are no guarantees, and it’s important you understand a company’s motives and strategy before forming your decision.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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