The many issues of rights issues

Business Times - 06 Jun 2009

SHOW ME THE MONEY

During bear periods, they face different market reactions and possible abuses by controlling shareholders

By TEH HOOI LING, SENIOR CORRESPONDENT

COMPANIES worldwide are frantically raising cash to fill their coffers in preparation for a potentially long dry spell in the economic cycle. Combined, they have raised US$77.6 billion through rights issues from the start of this year to June 4, data compiled by Thomson Reuters shows. That's a 39 per cent jump from the same period a year ago. And last year itself was a record year, with a total of US$158 billion raised - a 124 per cent jump from 2007. In the last 12 months, corporations globally have raised US$180 billion.

The country where companies have raised the most through rights issues is the United Kingdom. Sixteen companies there tapped existing shareholders for a total of US$26.5 billion. They accounted for about a third of the amount raised through rights issues worldwide. Australia came in second, with US$10.2 billion raised.

And Singapore has definitely punched above its weight in terms of rights issue funds raised so far this year. In the past 12 months, corporate Singapore has tapped shareholders for US$7.3 billion. Companies here have tapped the market for just under US$6 billion this year - six times the amount raised during same period last year. The Republic is ranked fourth, behind France with US$6.2 billion raised this year.

Among the big fund raisers are CapitaLand and CapitaMall Trust, Keppel Land and NOL, which announced its rights issue this week. Earlier in the year, when market sentiment was still bearish, companies that announced rights issues were punished by having their shares sold down.

I looked at seven companies that announced rights issues earlier in the year - Ascendas Reit, HG Metal, CapitaLand, Osim, CapitaMall Trust, Bukit Sembawang and Chartered Semiconductor. These stocks under-performed the Straits Times Index significantly after announcing their issues. Two days after the announcement, the average under-performance was a hefty 10 percentage points. Chartered Semicon's rights issue got the roughest reception. On March 9, when talk of a rights issue hit the market, Chartered's stock under-performed the STI by 14.3 percentage points. The statement was then loaded on to the SGX website at 8.45pm that day. The following day, the stock under-performed by 41 percentage points. And on the two days after, it continued to under-perform - by 9.3 and eight percentage points respectively.

The notable exception among big-cap fund raisers is CapitaLand. Its share price surged after its rights issue was announced. Probably, the market heaved a sigh of relief, as talk of an issue had been circulating and weighed heavily on the share price. On the day the issue was announced, CapitaLand's stock out-performed the STI by 10 percentage points.

I also looked at seven companies that announced rights issues last year - K-Reit, Olam, Parkway, Mapletree Logistics Trust, KS Energy, Popular and DBS Group. Two days after news of their cash calls was released, these stocks fared 9 percentage points worse than the STI. I did a similar study for the years 2000 and 2002 - and the findings were similar.

Sharp readers would have noticed that the periods mentioned above were all bear phases. Indeed, now that sentiment has turned, rights issues are welcomed by investors. For example, when NOL announced its rights issue on Tuesday this week, its stock outperformed the STI by 10 percentage points. And the next day, it outpaced the market again, by another 3.8 percentage points.

The other form of fund raising - via private placement - exhibited slightly different stock price patterns. In the days prior to a placement announcement, the stock price usually ran up noticeably. But when the news was out, the stock would slump.

From an existing shareholder's perspective, under normal circumstances, a rights issue is preferred over a placement if the shares are issued at a discount. New placements at a discount to new shareholders disadvantage existing shareholders - their stake would be diluted without any compensation.

However, there could be cases of existing minority shareholders being forced to pump in good money after bad when a company launches a rights issue. The minority shareholders are 'forced' to subscribe if the rights are offered at a very deep discount to the then-market price of the shares. Management or the majority shareholders have incentives to raise new funds to prolong the life of the company, even when it is obvious that it doesn't have a competitive edge and is losing money. By launching a rights issue at a deep discount, in anticipation of the sell-down of the shares upon the announcement of the issue, management and majority shareholders are in effect 'forcing' minority shareholders to pump in new money, which would be against their interest.

The more a controlling shareholder expects the market reaction to be negative, the more he will be willing to 'force' the market to underwrite it by making use of higher levels of discount, note Michele Meoli and Stefano Paleari of Bergamo University in Italy and Giovanni Urga of Cass Business School, London (UK).

In their study, they analysed rights issues in Italy from 1996 to 2005 - and found evidence of abuse by companies in financial distress. They thus suggested a limit on the discount that a rights offer can be priced at.

As it happens, in Singapore, most of the big cap stocks have seen their share prices significantly out-perform the market subsequent to the rights issue. The notable exception is Chartered Semicon, whose share price under-performed the STI by some 30 percentage points from 10 days prior to the rights issue announcement.