Why Are Companies Asking Investors for Money?

Companies are increasingly turning to shareholders for cash, but should investors take them up on their offer to buy more shares?

James Gard 26 May, 2020 | 10:31AM
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In the Covid-19 crisis, UK companies are increasingly turning to investors to raise money. But should investors take these firms up on their offer and what does all the jargon mean? We answer some of your key questions. 

Why are Companies Doing This? 

There are a number reason that firms turn to investors to raise cash. Hotel chain Whitbread (WTB), which has been hit hard by the lockdown's effect on restaurants, hotels and bars, is trying to raise just over £1 billion to shore up its finances during the coronavirus crisis. At other times, businesses use the money to invest to expand or to fund acquisitions, such as Boohoo (BOO) recently, which raised £200 million in 24 hours from investors to buy more brands.

What's a Rights Issue? 

It's a more formal process compared with other methods of raising money and gives shareholders more options. Rights issues offer new shares to existing investors, be they fund managers and pension funds who may own a significant chunk of the business, or retail investors who may own a handful of shares. 

Under a rights issue, an investor is offered new shares in proportion to ones already owned. For example, in a 3-for-1 issue, you are offered three shares for every one you currently hold. The price of the new shares is often discounted to tempt investors to buy them – in a recent rights issue, Aston Martin Lagonda (AML) issued new shares that were priced 86% below the closing price the day before - unsurprisingly, 98% of investors took up the offer. Under a rights issue, you have some options: buy all the shares allotted to you (your "rights"), sell the right to buy the shares, or let them lapse (effectively do nothing).

What's a Share Placing?

Also known as an open offer, a share placing is another method of raising money from investors. Catering firm Compass (CPG) is using a share placing to raise £2 billion, for example. 

A placing can bypass retail investors (which can be controversial), instead allowing the biggest shareholders to snap up more shares in a business. 

Placings are usually for smaller sums of money than rights issues and less admin is involved for the company. A simple share placing is not pre-emptive (see below) in that both existing and new shareholders can be offered the shares. An open offer is a type of placing that must be offered to all existing shareholders.

In an open offer, investors' choices are more restricted than with rights issue: you either take up the offer or let it lapse, and those shares (your “entitlement”) are sold to someone else.

Can You Explain Some of the Jargon?

Share placings and rights issues are forms of corporate actions that companies are required to tell shareholders about. 

Pre-emptive means that existing shareholders are offered the shares before new investors. In Whitbread’s case, it’s a non pre-emptive placing because the offer is available to both existing shareholders and new investors. 

Ex-rights price is the share price after the rights issue. 

What Happens if I Say No? 

If you say no, you are left with the same amount of shares as before, but they're now worth less because there’s more of them in issue. This is know as a dilution. So if a company had 100 shares in issue and you own two of them, you have 2% of its stock. If it issues another 100, bringing the total to 200, but you still hold just two shares, you now only have 1% of its stock.  

When a company announces a rights issue, the existing share price often falls. Whitbread shares fell more than 11% on the day of the announcement on May 21, for example. This is because investors know that if the rights issue shares are discounted heavily, there will be cheaper shares on the market at some point to buy. Investors also fear that a rights issue is a sign a company is struggling financially.

What if I Take Up the Offer?

Fear of dilution often persuades people to take up the offer. If the company is struggling, your shareholding could be worth more in future if it turns things around. But you may have more confidence in the company, for example in a high-growth tech stock, and want to take the opportunity to buy new shares before they rise further.

Can it Go Wrong?

The opportunity to buy more shares should been evaluated on a case-by-case basis, as investors are effectively being asked to take a punt on the company’s future fortunes (and its share price).

Buying more shares in a poorly performing company is a risk investors could end up regretting. For example, Royal Bank of Scotland raised £12 billion from investors in 2008 before being rescued by the Government - its share price is still yet to recover to 2008 levels.

Conversely, you could be offered shares in the next Apple or Amazon - or closer to home, FeverTree and Boohoo - and kick yourself you didn’t buy more when you could.

What do Companies Get Out of It?

A capital raising is usually cheaper than going to the bank and trying to borrow money and less risky than issuing bonds. This is because if a company collapses, shareholders get nothing but bondholders have more rights.

In the current crisis, companies need money to help them make it through to the other side  - Compass says the share placing will "allow us to weather the crisis", while Whitbread says the rights issue is ensure it "emerges from the Covid-19 pandemic in the strongest possible position". 

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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James Gard  is content editor for Morningstar.co.uk