Deciding whether to take part in a capital raise is not always an easy matter. On the one hand, there may be personal circumstances to consider, namely one’s finances. On the other hand, the decision may be influenced by the structure of the capital raise, as well as the outlook for the stock in question.
If we cast back to the GFC, in many cases those who bought into capital raisings during that period have been rewarded handsomely with long-term gains. Consider Wesfarmers (ASX: WES), which conducted an entitlement offer at $13.50 per share, or Macquarie Group (ASX: MQG), which ran a Share Purchase Plan at $26.60 per share. Even Commonwealth Bank (ASX: CBA) issued shares at $26 each to retail holders through an SPP in 2009.
However, not every offer has delivered holders with gains. Consider Santos (ASX: STO), which raised funds at $12.50 per share through an entitlement offer in 2009. Meanwhile, in 2011, Seven West Media (ASX: SWM) raised more than $1.1 billion through a placement and separate non-renounceable entitlement offer. Today it is worth just a fraction of that value.
Because each deal needs to be analysed on its own merits, it’s important that you take into account a wide range of considerations. Here are some of the key considerations to consider before participating in a capital raise.
Investment strategy and portfolio
First things first, consider whether you are investing for the short-term or long-term. If the stock buckles under selling pressure when it resumes trading, how will you respond? What happens if the stock falls below the issue price once you have been allocated shares? If the stock rises above your expectations, will you continue holding all your shares or take profits? Will your portfolio be too skewed towards the stock in question if you participate in the capital raise? All of these thoughts should be at the forefront of your mind before you bid for shares via a capital raise.
It generally makes sense to wait as long as possible before submitting a bid in a capital raise. This will provide you with enough time to compare the last trading price of the stock against the offer price. You can then assess whether you believe the stock is likely to remain above the offer price, in effect, providing a benefit similar to arbitrage.
However, if you bid too early, you may end up locked into paying more for shares than it would cost to buy on-market. Do note, however, in some exceptional instances, mostly among small-cap shares, the company may have discretion to issue stock on a first-come first-serve basis, which could mean that you need to apply quickly to avoid missing out.
Offer discount size
Weigh up how ‘generous’ the discounted share price is in relation to the current trading price. The higher the discount, the more likely it is that you will have an incentive to apply. However, you should also look at trading activity in the lead-up to the raise, which may have artificially ‘inflated’ the company’s share price and thus the size of the discount. It may even prompt selling on the news.
Stock outlook and use of the funds
In recent months, many of the capital raisings across the ASX have been akin to an emergency raise to shore up the company’s balance sheet. This means either reducing debt or stockpiling cash to ride out the economic downturn. These types of practices are less likely to see a return on equity, but the removal of uncertainty as to the company’s outlook can help support the strength of the company’s share price.
Meanwhile, for some companies, capital raisings can also be an opportunity to accelerate growth, either organically or through acquisitions. Zip Co (ASX: Z1P) is one such example, recently tapping the market for additional capital to accelerate its push into the US by acquiring QuadPay. Regardless of the situation, you should consider the appropriateness of how the funds will be used by the company as well as management’s track record at generating a return on equity.
If you don’t take part in a capital raise and forgo the opportunity to ‘average down’, your ownership in the company will be diluted. That is, you own a slightly smaller proportion of the company than you did before because while the total shares you own remains the same, the total number of shares on issue has increased. That’s not to say one should bid for additional shares just to avoid dilution, as the rest of these considerations should also be assessed.
Also keep in mind, post-capital raise, there is the possibility that the share price may face more resistance reaching its old highs again, at least in the near-term, if at all. While there are frequent exceptions that go on to reach new highs, it’s important to remember that a capital raise increases the number of shares on issue. If the stock were to remain the same price, it would effectively mean that the company’s valuation has increased, when it may not always be warranted.
Webjet (ASX: WEB) and Flight Centre (ASX: FLT) are two shares that have seen significant dilution in 2020. Many investors have bought shares in these companies anticipating their share prices to recover to the ‘old’ highs, however, those old highs would correspond with a significantly higher valuation for the companies. In fact, such was the dilution in Webjet, when its shares were recently trading at approximately one-third of their value from January, the company was valued almost as much as pre-COVID.
Scale backs and oversubscriptions
In a large number of instances, share purchase plans may be oversubscribed and your allocation will be scaled back. There are different formats for this scale back, albeit it is usually a set percentage across all retail holders. Having committed these funds, you will need to wait for your refund to be processed, which could create an opportunity cost if you were looking to invest in other shares.
At the other end of the scale, some entitlement offers allow retail shareholders to apply for additional shares in excess of their entitlement through an oversubscription facility. Where a capital raise is less popular among retail shareholders, you may be able to acquire extra shares. If there is excess demand for the oversubscription facility, that portion of the capital raise may be subject to scale backs and refunds.
Do you have surplus funds to participate in a capital raise? Some investors try to execute a strategy where they sell their existing shares as soon as the stock is released from a trading halt so that they may ‘recycle’ these funds and buy back the shares at a lower price through the capital raise. Investors may anticipate that the share price will likely drift lower towards the capital raise price, as this might be perceived as a better reflection of where the stock should be valued.
Not only is it possible that the share price might not drop to the capital raise price, as has been the case for Cochlear (ASX: COH), but there are two other risks. First, there are tax considerations that you should consider and seek advice in this respect. Secondly, there is no guarantee that your entitlement will be filled. The offer may be oversubscribed and subject to a scale back, leaving you with less shares in the stock than you originally held. This is why it is always useful to have some cash held aside in your trading account for any opportunities that emerge.
SelfWealth Ltd ACN 52 154 324 428 (“SelfWealth”) (Australian Financial Services Licence Number 421789). The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. Taxation, legal and other matters referred to on this website are of a general nature only and should not be relied upon in place of appropriate professional advice.