Double whammy for DIY investors as investments are diluted and income dries up

Retail investors have been hit particularly hard during the pandemic as up to 150 London-listed companies rushed to raise much needed capital and batten down the hatches throughout April and May – writes Christian Leeming.

One of the first effects was that companies sought to hang on to as much cash as possible resulting in dividends being scrapped, or even withdrawn, across the board; for those investing for income, life suddenly looked a little less straightforward.

There have been a raft of profit warnings, but the number of rights issues and placings – traditionally seen as a cry for financial help – speak of companies with previously strong balance sheets facing extraordinary, and unforeseen circumstances.

In response to a sudden and universal shutdown, rules on capital issuance were relaxed,  dramatically cutting the time taken to raise new funds; unfortunately, smaller investors are often shut out of fundraisings as the most efficient way to get a placing away is to City institutions and investment funds.

In an emergency a company can sell up to 10% of its value in a private placing and the fear is that this is being done on a virtual handshake, at discounted prices that disadvantage the DIY investor.

‘the fear is that this is being done on a virtual handshake, at discounted prices that disadvantage the DIY investor’

Investopedia warns of the ‘danger’ of share dilution which happens when a company issues additional stock, thereby reducing shareholders’ ownership in the company when these new shares are issued.

In its example it assumes a small business with 10 shareholders, each owning one share, or 10%, of the company; if investors receive voting rights for company decisions based on share ownership, then each one would have 10% control.

Then it supposes the company issues 10 new shares and a single investor buys them all; there are now 20 total shares outstanding and the new investor owns 50% of the company.

Meanwhile, each original investor now owns just 5% of the company—one share out of 20 outstanding—because their ownership has been diluted by the new shares.

Share dilution may not always be seen to be a negative – the cash could sometimes be earmarked for expansion or acquisition; however, in this instance the cash was urgently needed to shore up creaky balance sheets and put the shutters up.

Because things happened so fast, treatment of retail investors may now be ‘fairer’ than the way in which some were treated earlier on in the crisis, but DIY investing platform AJ Bell reports that of the £10bn raised by 153 companies only seven offered cheap shares to retail investors.

‘of the £10bn raised by 153 companies only seven offered cheap shares to retail investors’

Shares were sold at an average discount of 11%, leaving retail investors reeling at the double whammy of diluted ownership and typically a falling share price.

Traditionally, shareholders have equal rights over new issues above 5-10% of the total share capital, but this threshold was temporarily raised on guidance from the Financial Conduct Authority and the Pre-Emption Group.

Recognising the need for greater flexibility during the Covid-19 crisis, the industry body said investors should consider supporting issuances of up to 20% of share capital, up until September.

A number of companies used the accelerated placing of new shares with big institutions, with some pretty dramatic results.

ASOS announced a £247m fundraiser which was said to be four-times oversubscribed by existing institutional shareholders at a price of 1,560p – down from 3,000p before the sell off; although excluded from the placing, retail investors will have enjoyed the market’s initial response as shares added 41% to 2,200p, and have now pushed on to 3,221p.

WH Smith was another well regarded stock to use the tactic – it raised around £165.9m through a share placing to shore up its balance sheet after the outbreak forced it to close its travel business and the majority of high street stores.  It placed 15 million shares with institutional investors at a 4% discount of 1,050p, representing 13.7% of its previous share capital.

Predicting that the virus pandemic would initially cut client net fees by 70%, with a 35% overall fall by December, UK and overseas job agency Hays launched an immediate £200 million institutional fund raising as it looked to bolster its finances.

As a consequence of this institutional bias, DIY investors are finding their stakes significantly diluted by the new shares on offer.

Ted Baker’s plans to raise £95m through an open offer and firm placing at 75p per new share to institutional investors would have seen shareholders that chose not to participate diluted by 74%.

The deal came with the sweetener of a further £10m through an offer for subscription, but investors will not have enjoyed seeing its shares tumbling by 9.3% on the announcement – to just 139p, having traded at £31 just two years ago.

‘leaving retail investors reeling at the double whammy of diluted ownership and typically a falling share price’

Premier Inn owner Whitbread took a different tack by choosing to generate £980 million through a rights issue, where existing shareholders were offered one new share for every two they own.

This gives small shareholders the same opportunity to buy discounted shares — in this case the offer was a 37.4% reduction to the 2,395p theoretical ex-rights price* when adjusted for the new shares – and 91% of shareholders decided to support the issue.

Shareholders choosing not to buy the shares are still able to sell the rights, with this nil-paid price being the difference between the issue price and ex-rights price.

Whitbread’s fundraising took three weeks to complete, but many companies have speeded the process up by going directly to institutions, thereby avoiding the delay of having to publish a detailed prospectus.

Of the fundraisings in April and May, the £2 billion raised by catering company Compass was not just the biggest but it was the first to include retail shareholders.

This was made possible by the PrimaryBid platform, which enables companies to include a retail element alongside the usual institutional placing; this approach is now much more commonplace, but there has been growing unrest from DIY investors excluded from the process watching fund managers making a quick buck and wondering why they are always at the back of the queue.

*A theoretical ex-rights price, or TERP, is defined as the ‘theoretical’ price a share will trade at following a rights issue. This happens because more shares have been issued, and they are usually offered at a lower price to attract buyers.

This is reflected in the share price once the fundraising is closed; the extent of any dilution is a result of the number of rights issue shares acquired.