At a time when banks across the U.S. are scrambling to repair balance sheets, and when traditional sources of funding are drying up, bankers may want to take a closer look at a capital raising technique that’s popular in Europe but virtually unheard of stateside: “rights issues.”
Rights issues are a pretty simple concept. A company offers the right to buy additional shares, directly, pro rata, and at a discount to existing shareholders. The process is quicker than a traditional stock offering, taking only about 30 days, and the fees are roughly half — about 1.5 percent — of what bookrunners charge for an IPO. Rights offerings do dilute the value of existing shares, but they are still a much better deal for rank-and-file shareholders than the sweetheart stock sales that Washington Mutual and National City have recently struck with private equity firms. Those deals severely diluted small investors’ stakes and marginalized them.
With a rights issue “at least you’re not diluting shareholders without giving them a chance to participate in what you’re doing,” says Brad Hintz, a securities industry analyst at Sanford C. Bernstein in New York. Even though Bernstein only conducts research for institutional investors, retail investors have sought Hintz out, complaining about the spate of private equity deals struck by financial institutions. “They’d like to participate on the same terms as the government of Kuwait.”
It’s not entirely clear why rights offerings are so unheard of in the U.S. Back in the 1950s and 1960s a few household names, such as GM and Chase Manhattan, did rights issues, but those were to fund growth projects, not to repair balance sheets. Andy McGee, a partner at Oliver Wyman, attributes it to the fear of being the first to market with what amounts to a new product and the uncertainty of the process. What’s more, a public road show accompanying a rights offering, complete with the inevitable irate investors, might air a bit too much of the company’s dirty laundry, creating a perception of weakness in the marketplace. Fund raising among private equity firms and institutional investors, on the other hand, can happen more quickly and with less disclosure.
None of these rationales can be dismissed. The untried is always a risk, and why not take capital from a small circle of investors willing to pony up billions on short notice? The problem now is those sovereign funds, pension funds and other institutional investors that helped U.S. banks raise about $400 billion are crying uncle. More capital raising must occur, perhaps another several hundred billion dollars, but those early investors are pulling back from additional commitments as they watch their earlier investments tank. It’s true that private equity firms are showing an interest in upping their investment in the industry, but given regulatory complications it’s unclear how much or how willing they will actually be to step in. (See Inside Track for more on this issue.)
But bankers should ask themselves: Even if private equity could play a larger role than it does today, should bankers continue to dilute the shares of most investors by arranging deeply discounted stock sales to private equity firms and a few large institutions? Will that disenfranchise these investors, many of whom are quite loyal stockholders? And what of community banks that need to raise capital but don’t interest the private equity firms because of their size, or because their discount is not steep enough. (After all, private equity will be looking at very distressed bargains, not relatively solid institutions looking to boost capital ratios.)
If what’s going on in Europe is any indication, U.S. banks may have more than private equity to fall back on. Rights issues in Europe are not just more popular than in the U.S., they are having a record-breaking year. This is, in part, thanks to the fact that regulations in most European countries oblige companies to offer existing shareholders new stock first so they can maintain a proportional stake in the company. That right is unusual in the U.S.
Through June 30 of this year, European financial firms have announced plans to raise $78.5 billion through rights offerings, exceeding the total raised by companies during all of 2007, according to data compiled by Bloomberg. Some of those rights offerings include Royal Bank of Scotland, $24.4 billion; UBS, $15.7 billion; Paris-based Société Générale, $8.4 billion; and Banca Monte dei Paschi di Siena SpA, Italy’s number three bank, $7.8 billion.
So unless European investors’ behavior is fundamentally different than U.S. investors’, bankers in the states should be heartened and reasonably optimistic that rights offerings could be an effective capital raising tool. Rumors are that as financing options dwindle, more boards of directors are considering rights issues for the first time. It’s about time. (c) 2008 U.S. Banker and SourceMedia, Inc. All Rights Reserved. http://www.us-banker.com http://www.sourcemedia.com
