Small shareholders have seen this trap before and they should be really angry this time around.
After the global financial crisis, companies, both large and small, high quality and not, raised a heap of much needed cash through share placements and non-renounceable share issues.
The cash was great for the company – helping it to survive in tough times – and was fantastic for the new “cornerstone’’ shareholder, who profited by buying in at a reduced share price.
However, it was usually terrible for existing investors because their stake in the company was effectively diluted or reduced by the share issue and they were often unable to buy shares at the same price – although sometimes there was a limited share purchase plan.
Even worse, the low buy in price often became a new – and lower – benchmark price for the now diluted stock.
Placements of 25% will turbocharge the rip-off
This time the same rip-off is back with a turbocharger strapped to it with the Australian Securities Exchange (ASX) deciding to allow companies to make placements of up to 25% of their shares on issue, rather than the old limit of 15%.
That is a massive reallocation of value and the potential for value transfer from existing shareholders to “new” shareholders should be obvious – a larger version of the loyalty tax that sees people unwilling to rotate their insurance, energy provider and bank every couple of years paying through the nose.
Shareholder purchase plans and rights issue not the full answer
The only small consolation for small shareholders such as private investors and self-managed super funds is that they will now be allowed to buy shares at the same price through a shareholder purchase plan or a pro-rata issue, which obviously still leaves them at a significant disadvantage.
For some unknown reason the regulator, the Australian Securities and Investments Commission (ASIC), which is meant to keep things fair between all investors, has rubber stamped the idea.
While on paper having the placement plus either an SPP or pro-rata issue seems to keep things fair, there are a number of very good reasons why it doesn’t.
New shareholders get free value from existing shareholders
For one, the whole idea of these placements is to quickly get cash through the door by holding out some tempting value to the “new’ shareholder – value that comes at the expense of reducing or diluting the economic stake in the company held by the existing shareholders.
This can still easily be done in a number of ways – by keeping the size of the SPP small or by making the pro-rata issue non-renounceable.
By keeping the SPP small, the company can effectively say that all shareholders were “offered’’ the same price but what they weren’t offered was the same volume.
If a small shareholder has their number of shares allocated in the SPP cut down, which often happens, they are effectively being diluted twice.
If they don’t have the funds to take part in the SPP at all they are only diluted once but by a bigger margin.
Non-renounceable rights issues can be even worse
It is a similar but possibly even worse story with a non-renounceable rights issue.
Because the small shareholder can’t sell their “right’’ on to another investor, if they can’t afford to take it up, their large dilution is automatic.
However, a second dilution can then occur because the shares they couldn’t take up are snapped up instead by the underwriter of the issue and are taken up by someone else.
These large placements are enormously popular at times of financial stress because they allow the issuing company to quickly and relatively easily get cash through the door to bolster the balance sheet.
In the longer term they can also help the company to survive and thrive to the advantage of all shareholders.
Financial stress not an excuse
However, these times of financial stress are usually tough times for small shareholders as well, which leaves them highly vulnerable to not being able to take up share issues or SPPs.
Their existing stake in the company is effectively reduced and there is precious little they can do about it but also complain at the annual meeting – which usually only delays the refreshments.
They can also pull out of companies that are particularly egregious in their placement plans and reward other companies that treat all shareholders with more fairness.
There are some options
Perhaps one option for small shareholders is to invest through large listed investment companies such as Australian Foundation (ASX: AFI) and Argo (ASX: ARG), which are usually big enough and ugly enough to be able to make the right decisions during placements and potentially get a seat at the table.
The same goes for some of the listed small cap fund managers, if you prefer investing with the smaller end of town.
Another is to take part in all SPPs and rights offers to avoid or reduce dilution – if necessary, selling other shares to do it.
Perhaps predictably, the Australian share market is now set for a welter of large share issues, with some already announced and plenty more on the way.
It is frustrating and annoying that these periods of financial stress are used as a way to prey on the loyalty of smaller shareholders who remain the lifeblood of the share market and instead work to the advantage of the investment bankers and big, cashed up players.
Perhaps it is inevitable in some ways because companies still need a quick and sure-fire way to raise cash in these conditions and large placements do just that.
It would be nice if the ASX, ASIC and the companies themselves took some more time to consider the needs of small shareholders in designing all of their capital raising efforts.