Calculating the size of retail dilution in capital raisings

July 27, 2020

Here are extracts from recent columns in The Eureka Report which spell out the specific size of retail dilution in capital raisings.

Wesfarmers - July 21 column

It's very easy to bandy around huge numbers about the size of retail shareholder dilution but let's just look at a specific case study to demonstrate how dilution works.

One of the best examples is Wesfarmers from back in March 2009 when it paid a cabal of six under-writers $200 million in fees to help put together a $4.7 billion capital raising.

Wesfarmers had a retail heavy register courtesy of the Coles Group acquisition which was majority retail owned thanks to its popular shareholder discount card.

The raising featured a $900 million institutional placement at $14.25 and a 3-for-7 non-renounceable entitlement offer at $13.50, comprising a $1.9 million accelerated institutional component and a non-underwritten $3 billion retail component for its 474,000 shareholders.

Once Wesfarmers had pocketed $2.8 billion from institutions, it wasn't too fussed about the retail component and the offer document only assumed a 15 per cent take-up rate (see page 9), even though applicants were offered an unlimited ability to apply for shortfall shares.

Given the offer was almost 40 per cent in the money when it closed, it wasn't surprising that retail applications of $1.8 billion came through the door chasing the $3 billion, but the board scaled back the “overs” by $100 million only accepting $1.7 billion and leaving it $1.3 billion short.

The way to calculate the dilution in today's dollars is to assume there was no $900 million placement at $14.25 and 100 per cent take up of the $3 billion retail entitlement offer at $13.50, rather than a $1.3 billion shortfall.

With the stock closing at $46.53 on Friday, the two placement recipients (CBA's Colonial First State and LA-based Capital Group) have made almost $2 billion on the placement, which is straight dilution for all Wesfarmers shareholders, the majority of whom were retail.

However, even heavier dilution comes from the $1.3 billion worth of retail entitlements not taken up at $13.50. There was no compensation either as it wasn't renounceable. The foregone profit on those 89 million retail shares is today almost $3 billion, so the capital raising as a whole diluted the existing retail investors out of more than $5 billion.

However, this doesn't take into account the Coles Group demerger in 2018 so the total cost of the dilution is actually significantly higher again.

In hindsight, it would have been better for Wesfarmers to suspend dividend payments from the beginning of 2009 and conduct no capital raising at all. If it had done that for a couple of years the share price would be north of $50 today and retail investors wouldn't have been diluted out of more than $5 billion in value.

If any company owes their retail shareholder a make-good SPP that dilutes institutional shareholders, it is Wesfarmers and I'll be forwarding this column to them shortly with a request that they announce a $1 billion retail only SPP with their full year results to compensate for past dilution and help pay down debt.

Suncorp - July 28, 2020 column
Last week's column looked at the Wesfarmers case study to demonstrate how poorly structured capital raisings can needlessly cost retail shareholders many billions in dilution.
In the case of Wesfarmers, it was $5 billion-plus, given that the stock has rocketed since its arguably unnecessary $900 million institutional placement at $14.25 and 3-for-7 non-renounceable entitlement offer at $13.50 in 2009 which finished $1.3 billion short.

We're going to look at other case studies to make the point about the unfairness of the system and today it is Suncorp which in early 2009 was 52 per cent owned by its retail shareholders when it announced a $390 million institutional placement at a 35 per cent discount of $4.50. This was twinned with a 1-for-5 non-renounceable with unlimited overs for retail at $4.50 to raise up to $967 million in total.

The $502 million retail offer finished $311 million short even though it was around 20 per cent in the money and retail shareholders were permitted to apply for unlimited shortfall shares. Participation rates were low during the peak of the GFC with investors traumatised by their losses. Suncorp received just $191 million in applications through the retail offer, including $56 million through the shortfall offer.

Suncorp shares closed at $8.98 on Friday night so the institutions who bought 86.7 million shares in the 2009 placement are enjoying $388 million in paper gains, before considering the solid flow of fully franked dividends over the past 11 years.

And if tens of thousands of retail shareholders had taken up all of the $311 million retail shortfall, this collective investment in an additional 69.1 million shares would be showing a profit of around $300 million.

Retail investors were diluted down from 52 per cent of Suncorp to a minority position courtesy of this poorly structured offer and the cost of this dilution measured today is around $500 million.

I've sent a copy of this item to Suncorp requesting that they launch a stand alone SPP at a 5 per cent discount to VWAP when announcing their full year results on August 21, in order to offer retail shareholders reparations and compensation for past dilution in the 2009 raising.

A company representative replied as follows:

As you have identified, Suncorp's retail shareholders were given the opportunity to participate in the 2009 entitlement offer. The fact that the retail entitlement offer was not fully taken up was as a result of retail shareholders electing to not to participate. All retail shareholders who participated in the entitlement offer received their full allocations, and all applications for additional new shares were also fulfilled. Suncorp today is well capitalised and reported Group excess CET1 at 31 March 2020 of $682 million.

Ah yes, the old “it's up to individual shareholders to decide and if they don't act rationally, don't blame us”.

It's a known fact that even when capital raisings are well in the money during good times, it is extremely rare for a majority of retail shareholders to participate. Therefore, boards should structure their raisings to reflect this and the best method is by making a raising renounceable with non-participants compensated through a bookbuild of the retail shortfall at the end of the offer. We haven't seen a single one of them so far in 2020 as boards, egged on by the likes of Macquarie, deliberately and systematically dilute retail shareholders, all in the name of “certainty, speed and efficiency”.