In search of equity

  • Date:01 Oct 2012
  • Type:Company Director Magazine
Tony Featherstone reports on a new tool, available later this year, that will bring more transparency and fairness to equity capital raisings.


A new tool from the Australian Securities Exchange (ASX) will help the boards of listed companies better meet their corporate governance obligations around capital raisings and address concerns that some primary market issues lack transparency and disadvantage small investors.

ASX BookBuild will enable companies to price and allocate securities in equity raisings using ASX infrastructure and proprietary technology developed by On-Market Bookbuilds. Following market consultation, this world-first tool is expected to launch on the ASX in the fourth quarter of 2012.

It is a powerful idea. A potential conflict in some primary market issues, such as placements, is preferential allocations to institutional investors. An ASX-listed company might engage a lead manager to underwrite and/or distribute an offer to buy stock in a placement. In turn, the lead manager could invite certain clients to bid for stock, with other eligible investors denied an opportunity to participate in the offer, unless it is under-subscribed.

Limiting the number of eligible investors who participate in a placement can inhibit price discovery and lead to shares being issued at prices lower than they ought to be, which, in turn, creates more dilution for existing shareholders. There is a natural tension as the lead manager strives to get the best result for its corporate client that issues shares and its investing clients who buy them.

The problem for boards is that some shareholders may feel they have not been treated equally if they are denied access to a placement, or that there has been selective disclosure of volume and pricing in placements to larger institutional investors that gives them an information advantage.

Fairness in capital raisings is a huge issue for listed companies and their boards – and a point of contention for some proxy advisory and shareholder groups that feel too many listed companies panicked and issued equity capital too cheaply through placements at the height of the global financial crisis (GFC) in 2008 and 2009. Just over $100 billion was raised quickly to save many corporate balance sheets.

In 2010, the proxy adviser ISS Governance Services called for significant change in equity capital raisings in its much-quoted paper, Equity Capital Raising in Australia during 2008 and 2009. Industry superannuation funds and the Australian Shareholders’ Association criticised boards for allowing excessive dilution by approving heavily discounted placements that favoured institutional investors at the expense of some long-term funds and retail investors. They argued the real winners from GFC placements were investment banks that collected $1.9 billion in fees.

Boards and investment banks countered that heavily discounted placements were unavoidable when no one knew how the GFC would play out. They argued that the ability for corporates to raise more than $100 billion quickly via the ASX was a key factor in Australia avoiding the worst of the GFC; that many institutional investors were offered shares on a pro-rata entitlement basis; and that retail investors showed less interest in buying stock through share purchase plans that accompanied placements during the GFC. And, that it was easy to criticise capital raisings during the GFC with the benefit of hindsight.

Extreme uncertainty at the GFC’s peak meant some mistakes in the pricing and allocation of some securities were sure to be made. What is clear is the process for primary market issues needs to be modernised and conducted on-market using ASX infrastructure, rather than on a lead manager’s spreadsheet.

ASX BookBuild, in theory, helps companies ensure the widest possible market in Australia and overseas can bid for stock, while preserving the lead manager’s role in placements, and gives companies flexibility to attract investors that strengthen their share register and ensure there is excess demand for the offer, which in theory spills over into the secondary market for the securities.

Australian Institute of Company Directors chairman Richard Lee FAICD believes ASX BookBuild will help boards better meet their corporate governance obligations to all shareholders during equity capital raisings.

"This tool will create more transparency on how shares are priced and allocated in placements and thus give boards greater confidence that their company is tapping the widest possible range of investors for a capital raising and getting the best possible deal at the time," says Lee.

"I expect to see significant interest in ASX BookBuild from companies, regulators, institutional investors and retail shareholder representatives. The key is getting support from intermediaries that advise on capital raisings. I would hope they see the benefits of a tool that helps boards know shareholders are being treated as fairly and equitably as possible in the capital raising."

Prominent company director Stephen Gerlach AM FAICD says good boards deeply understand the rationale and in-principle terms of an equity capital raising and discuss parameters for the issue’s allocation.

"In my experience, boards think a lot about how much of the issue will be made to existing shareholders, the lead manager’s preferred investors and retail shareholders. Directors are well aware of the tension involved in offering a priority placement and meeting the needs of all shareholders."

Gerlach has been involved in many capital raisings over the past 20 years as a company director and corporate consultant. He is a former chairman of Santos and Futuris Corporation, a former director of Southcorp and the current Chancellor of Flinders University in Adelaide.

He says: "The big problem for boards is they sometimes feel in the dark about how the capital raising was conducted, how competitive the bidding for stock was and whether the best possible final price was achieved. This has implications for the company’s cost of capital and the fairness of the capital raising for all shareholders."

Gerlach understands criticism from long-term institutional investors, such as industry super funds and retail investors, about equity capital raisings.

"There have been a number of very heavily discounted placements in the past five years, where companies had their hands tied behind their back because they needed capital quickly, and could not do much about the size of the discount," he says.

"It is no surprise there was criticism from long-term investors who did not have an opportunity to participate in the offer [unless it was undersubscribed] and maintain their position in the stock. Invariably, their position was diluted and there was nothing they could do about it."

The lead manager’s role in equity capital raisings can be an issue.

"They have an extraordinarily powerful position in these capital raisings," say Gerlach.

"Companies need their lead manager to distribute stock in the issue and raise the capital. But from a board’s perspective, you don’t always know who the lead manager is talking to about the issue and how it decides to allocate stock."

He says ASX BookBuild has advantages for boards. "At a minimum, it should make boards feel confident that all eligible shareholders had a fair opportunity to bid for stock on-market and that the final price was truly competitive and the best outcome for the company’s cost of capital. This tool, while complex, certainly offers a much greater level of transparency in equity capital raising than currently exists in full pro-rata entitlement issues, and it helps boards address potential conflicts of interest."

Richard Murphy, ASX general manager, capital markets, describes ASX BookBuild as a "very important development for equity capital raisings in Australia and a world-first for ASX".

He says it could be used for other capital raisings, such as initial public offerings (IPOs), over time.

Murphy says: "It takes the efficiency and integrity of the ASX secondary market, where all investors can see prices, to the primary market for equity raisings, which historically has had less transparency because it relies on market participants to determine how stock in new issues is distributed to investors. Most of all, it helps ASX-listed companies ensure the final bid price is the truest reflection of investor demand."

Murphy emphasises that ASX BookBuild is not mandatory. "Companies and their advisers can still use traditional processes for equity capital raisings if they choose," he says.

Companies that use ASX BookBuild are expected to pay a fee based on a percentage of capital raised. Pricing details were not available as Company Director went to press.

The foundation for ASX BookBuild is technology developed by On-Market Bookbuilds. Founder Ben Bucknell, a former Allens lawyer who also worked at Macquarie Group, saw a discrepancy between what companies, boards and investors wanted in capital raisings, and what current market practices delivered. He set out in 2009 to develop a better process and spent two years researching and testing the idea on market participants, companies and boards.

Bucknell says: "I’d seen equity capital raisings from both sides: what the law said could be done, and what investors thought should be done. Market practices for the process of raising equity capital had not changed in a long time, despite considerable improvements in market technology and infrastructure. There was a clear opportunity to bring the integrity of the ASX secondary market to bear in the primary market for new issues and create a better outcome for everyone involved.

"I don’t see ASX BookBuild as a criticism of current practices in equity capital raisings. The reality is that companies, boards, lead managers and investors have had to do their best with the tools available to price and allocate securities. What we are doing is taking advantage of technology and using ASX market infrastructure to ensure placements can be done on-market rather than off-market."

Bucknell makes a good point. An investor who buys BHP Billiton shares in the secondary market can see its price and knows there are rules that ensure all investors are treated fairly when bidding for stock. Those principles do not always apply in primary market issues due to less transparency and sometimes less efficient price discovery, because the final match price is not based on whole-of-market demand.

Securities price-matching and allocation might sound like exchange jargon, or something for chief financial officers and investment bankers. But fairness in equity capital raisings strikes at the heart of governance: boards must ensure the interests of all shareholders – not just large institutions – are considered.

Placements are much faster than rights issues to raise equity capital, but they may not provide all eligible investors with an opportunity to participate in an offer.

More listed companies are taking steps to ensure retail investors can participate in offers, or sell their rights through renounceable rights issues that have a value and can be traded. And, ASX is looking at ways to modernise and speed up rights issues. But even the best-case scenario of 16 days is still vastly longer than a placement when raising equity capital, and the delay leaves companies open to greater market and execution risk when raising equity capital in a volatile sharemarket. In addition to IPOs and placements, ASX BookBuild could be used for the sale of renounceable rights.

On-Market Bookbuilds managing director Rosemary Kennedy says ASX BookBuild has been designed to preserve the lead manager’s role in the equity capital-raising process, provide companies with more levers to get the best outcomes and reward price-leading bids and guarantee allocations for institutions that bid at or above the final Bookbuild price.

"The starting point with ASX BookBuild is to acknowledge the lead manager’s central role in equity capital raisings. It is not about lowering adviser fees or reducing their role in the process," she says. "ASX BookBuild gives lead managers and underwriters levers to get the best price by accessing all-of-market demand, while ensuring the needs of institutional bidders are met.

"Lead managers can use ASX BookBuild to differentiate themselves in the market, by acknowledging corporate governance considerations for boards around equity capital raisings, while getting the fairest and best possible outcome for their corporate and institutional clients with the final match price."

Kennedy says underwriters can use ASX BookBuild to reduce their exposure to a shortfall before on-market bidding opening, by rewarding institutional, strategic investors and existing shareholders who bid through the Priority Allocation function. This also helps companies and lead managers attract investors that strengthen the share register.

"The levers we designed in ASX BookBuild strike a good balance between attracting the right investors for the company, ensuring the best final possible bid price, and retaining the ability to issue under the demand curve and scale back bids to support shares in the aftermarket."

How it works:

Working with its corporate client, the lead manager can use ASX BookBuild to:

  • In the first stage of the allocation process, set a Priority Allocation for bidders that increases their bids to, or above, the final match price.
  • In the second stage, allocate shares on a pro-rata basis to price leaders (those that bid above the match price), subject to certain conditions.
  • In the final stage, the remaining unissued shares are distributed via pro-rata allocations to all bids equal to, or above, the match price.

An example supplied by ASX

Consider an ASX-listed company that trades at $1 a share and seeks 100 million new shares. The company selects a lead manager, whose proposal includes using ASX BookBuild.

The company agrees on an "underwritten" price of 90 cents (a 10 per cent discount to the share price) with the lead manager, and both agree to key parameters for:

  • The Priority Allocation – 50 per cent of offer (disclosed).
  • The Price Leaders Allocation – 50 per cent (not disclosed).
  • Excess Coverage (how many times the book is covered) – 150 per cent (not disclosed).

The lead manager then secures priority bids for 100 million shares. ASX Bookbuild opens to on-market bidders (using a dedicated ASX Code) and the lead manager reviews bookbuild parameters once they gauge market demand.

At 150 million shares (the excess coverage amount based on 150 per cent of 100 million shares), the match price, or highest price where demand meets excess coverage, is 95 cents. The company and lead manager then initiate the bookbuild close.