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Friday, 24 November 2017

ECM 2005 - Innovation down under

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Australia follows its own path with ECM. From hybrids to rights issues and trusts, the market consistently devises original, effective and fair instruments that feed into one of the most transparent and widely invested equity markets in the world. Jasper Moiseiwitsch reports.

Australian equity markets are relentlessly innovative. Hardly a week goes by without a bank announcing some breakthrough financial product, typically with snappy monikers such as Perpetual Exchangeable Resettable Listed Securities, Renounceable Accelerated Pro-rata Issue with Dual-bookbuild structure or Convertible Adjusting Rate Securities.

But underlying the titles can often be found true financing innovation. Australia has its own regulations, investing culture and dynamics, and bankers there are routinely called on to devise means of navigating these peculiarities. For example, the Australian market has developed fairly complex systems for handling rights issuance.

ASX listing rules prohibit companies from issuing more than 15% of their equity in a 12-month period. Companies can get around this restriction by using rights, which are exempt from the restriction because they are offered to all investors on a pro-rata basis.

But Australian bankers have had to thread their way through continuously changing regulations. During the 1980s and into the early 1990s, Australian issuers typically raised equity via rights issues which were suitable, quick and easy to execute. However, in the early 1990s the Australian Stock Exchange decided that rights offers had to include a prospectus. That extended the timeframe for such deals and increased banks’ underwriting risk for such transactions. Banks were still allowed to sell rights to institutional investors without issuing a prospectus, but that tilted the issuance toward the professional investor market, which annoyed retail investors.

So in 2001, ABN AMRO Rothschild and UBS innovated the “jumbo” (an A$153m fundraising for Adsteam Marine) which solved a number of problems. First, it allowed companies to do accelerated fundraisings that exceeded the 15% placement cap. Secondly, it allowed retail investors to participate in such transactions fully and equally with institutional investors.

A jumbo involves two tranches – a placement of equity (up to the 15% ceiling) and a rights offer. Because rights are offered pro rata to all existing investors they are not subject to the 15% cap, allowing companies to exceed that cap (thus the “jumbo” description). The bank goes out to existing institutional investors first, building a book for the placement and rights. Existing institutions are invited to bid for their pro-rata entitlement of shares and rights. Any shortfall is allocated to existing institutions that bid over their entitlement, or to new institutional accounts.

After this process is finished, unusually over a 24–48 hour period, the underwriters go to existing retail investors and offer them their pro-rata entitlement of rights at the price found in the institutional bookbuild. The retail offer can still take weeks to work through, however, the market already knows what price the offer has achieved and to what degree the new issue will dilute investors, so to all intents the offer is closed.

The jumbo was a major step forward for Australian equity markets, giving companies the means to achieve large-scale, accelerated fundraisings.

“While less of an issue now because the timetables have been reduced, historically when you did a normal rights issue the risk period was well over a month,” said Guy Fowler, UBS’s head of Australian ECM origination. “But with these accelerated deals you can get cash in the door and the securities trading. This permits finer pricing and hopefully lower cost of capital. It also facilitates firmer underwriting, because the market is more comfortable with taking on the market risk of an accelerated transaction.”

Macquarie Infrastructure Group, AMP, Qantas and Westfield among others have since successfully used the jumbo structure.

However, as the jumbo took hold institutional investors started to complain that these offers put a gun to their head. They were effectively asked to make an immediate decision on accepting a price on a rights package, when these issues were commonly tied into complicated M&A transactions. The institutions said that they did not always have the time necessary to absorb all the new information to make an investing decision, especially when these deals came without a prospectus.

That feedback led to another development in the rights market – the renounceable jumbo or Rapids. This structure allowed investors to renounce their entitlements on a jumbo offer. The rights are then put into a bookbuild, and investors that renounce their entitlements get the difference between the bookbuild price and the underwritten price of the offer.

Investors (including retail) are offered a bit of premium for declining a rights issue, which compensates for their dilution. This process offers an equitable means of handling such transactions, and the structure has done much to revive the rights instrument as a means of fundraising.

Macquarie introduced the first Rapids offer in December 2004 in an A$1.02bn issue from Macquarie Communications Infrastructure Group. The structure was replicated weeks later with an A$217.5m fundraising for Healthscope.

The instrument was also put to use in an ambitious A$831m fundraising – led by Citigroup, Macquarie and Merrill Lynch – for Macquarie Countrywide (MCW) in February 2005. The transaction comprised the second largest fundraising attempted by an Australian listed property trust, and it asked institutions to buy the deal on an accelerated basis at a tight discount, all while digesting news of a complicated acquisition announced by MCW. Investors also had to come to terms with their dilution: the new shares expanded the issuer’s equity base by 76%.

As it was, the leads had to absorb an A$4.3m shortfall on the deal. However, that shortfall was easily covered by their fees and the deal, on balance, was very successful.

“Rights issues have come in and out of fashion in Australia,” said Mark Bartels, Citigroup’s head of Australian ECM. “Issuers were starting to favour straight equity deals after regulatory shifts made rights unattractive. But the jumbo and then the Rapid structure, which are reasonably complex and require and immediate decision by an investor to participate in a deal together with shortening of the timetable, have pushed rights issuance back to the forefront.”

In property we trust

Australian ECM activity is dominated by trusts and yield-intensive issuance that has a large retail following. Markets are flush with liquidity. Employees make mandatory pension contributions to their pension funds, much of which is turned over to fund managers for investment in trusts that offer tax efficiencies.

Investors have been consistently well rewarded by trusts, which typically yield in the high single digits. The trusts tend to be well managed with strong corporate governance and conservative investment strategies. The bottom line is that the Australian ECM seems to be in extremely good health, with investors happy to continue putting new money in.

That has contributed to another Australian peculiarity – issuers are running out of domestic assets to inject into trusts. Bankers have already hit the outer limits with Australia’s real estate investment trust (REIT) market, with trust managers finding that they are few remaining decent assets left to claim.

So the market has been turning increasingly toward other assets with dependable long-term income streams – witness the many infrastructure trust fundraisings happening in Australia in recent times. It is also turning to offshore assets.

Australia’s equity investors are so comfortable with trusts that issuers are able to sell offshore assets, with the extra risks such investing presents, with little difficulty. Some of the largest property transactions in the US have been funded in the Australian equity markets, and domestic trusts routinely package exotic assets such as Czech shopping malls or Tokyo commercial buildings.

Such is the domestic faith in trust-style investments that issuers have been able to market “cash box” structures. Cashboxes are entities that list with few assets. They take investors’ money and typically reinvest the funds into listed securities.

In recent times these cashbox structures have evolved into venture capital funds that buy unlisted assets under fairly loose investing parameters. Recently listed companies such as Babcock & Brown Capital and Macquarie Capital Alliance Group have raised IPO funds with no particular mandate against which to invest. These funds maintain a “flexible investment style” (as noted in the B&B prospectus) and hold their funds until they come across a decent investment.

It is hard to imagine a similar kind of fundraising in the rest of Asia, where investors would be wary of putting money into asset-less entities with virtually an open mandate to invest. The potential for investor deception would be simply too huge. So it is a testament to the faith that the Australian investors have in equity markets and sponsors that cashbox structures can work in that market.

“Corporate Australia weathered some scandals in the late 1980s,” said Bill Best, an executive director within Macquarie’s ECM team. “However, most people think that Australian regulators’ response to those problems and those that have occurred since has been such that the integrity of the market has been preserved."

"The due diligence process which underpins the offers that come to the Australian Stock Exchange, and the disclosure regime which is in place once these offers are listed, have created a high level of confidence on the part of investors that what they see is what they get," said Best. "As a result, the right issuer with the right sponsor will be received by the market with quite a bit of goodwill.”

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