One thing that is more certain in the current environment is the likely need for a number of NZX listed issuers to consider raising equity in the short to medium term.
This publication explores:
the main equity capital raising alternatives, including the new 'ANREO' structure, and
some of the key legal considerations that a board will need to assess when deciding to raise equity during this period of market and economic uncertainty.
Need for equity capital
A number of issuers may face liquidity challenges in the coming months, particularly those companies with direct exposure to the economic consequences of the measures taken to combat COVID-19, including those impacted by the changing consumer behaviour brought about by social distancing and lockdowns.
In the short-term, such companies may maintain liquidity by drawing down under their existing debt facilities and reducing capital expenditure and discretionary operating costs. Some have already cancelled upcoming dividend payments. Beyond that, we expect there will be a need for some to raise equity capital to fortify balance sheets, repay debt, maintain compliance with banking covenant levels, address working capital requirements, meet operating and capital expenses, or simply to ensure prudent capital management in an uncertain time.
In this scenario, these companies can access a range of new and existing tools to raise equity capital quickly.
Two main options
A key consideration for the board of an issuer looking to raise equity capital will be the choice of offer structure. Due to the current market volatility, key drivers around the choice of offer structure will be the amount of capital required to be raised, funding certainty and timing, with issuers, investors and underwriters not wanting to be "on-risk" for any length of time.
In light of that, we expect the two main structures to be considered by issuers will be:
an institutional placement (potentially followed by a retail offer carried out by way of a share purchase plan (SPP)), and/or
an accelerated entitlement offer (potentially accompanied by an institutional placement1).
These two offer structures are not mutually exclusive. Institutional placements and accelerated entitlement offers have proven to be effective tools for issuers to raise capital quickly and effectively in previous times of uncertainty.
Institutional Placement and SPP
If an institutional placement can deliver sufficient capital for an issuer, then this structure provides the most certainty for an issuer. This is because of the speed with which a placement can be executed, typically being over a period of three to four trading days. As noted in our previous
publication, the number of shares that can currently be issued under a placement has been temporarily increased by NZX to approximately 25% of the share capital in any 12 month period (up from 15% normally to assist issuers during the market fall-out from COVID-19). However, a 25% placement may not raise sufficient capital, particularly if the issuer has suffered a significant fall in its share price since the outbreak of COVID-19 and/or there is uncertainty regarding how much capital it requires for its short to medium term needs. Once used, the 25% placement capacity will need to be refreshed by shareholders (by way of approval by ordinary resolution) before it can be used again. This is an important consideration for issuers who may need to raise capital more than once in the next 12 months. Issuers will also still need to carefully consider who will be able to participate in a non-pro-rata placement (for example, due to Takeovers Code2 or Overseas Investment Act restrictions) when determining demand.3
It has become common for issuers to undertake a SPP offer following an institutional placement to facilitate retail shareholder participation and counter the dilutionary impact of the institutional placement. As noted in our previous
publication, an SPP now allows all shareholders to purchase up to NZ$50,000 worth of new shares in any 12-month period provided the aggregate amount raised does not exceed 30% of the share capital of the issuer. The benefits of undertaking a SPP following an institutional placement are that:
it is perceived as being fair to all shareholders because a SPP can likely ensure that most retail shareholders are able to access at least their pro rata amount of the overall placement and SPP offer (therefore almost equivalent to a pro-rata rights offer);
the SPP does not need to be underwritten, meaning underwriters or sub-underwriters are not on risk; and
the issue price for the SPP can take account of a fall in share price after the institutional placement, with shareholders able to apply at the lesser of the institutional placement price and a VWAP over, for example, the final five business days of the SPP offer. This protects retail shareholders by allowing any new adverse event or circumstance arising after the announcement of the offer to be priced into the issue price.
However, issuers contemplating an institutional placement and SPP structure will need to carefully consider the size of the offer and the minimum net proceeds an issuer is seeking to raise. If an institutional placement and SPP cannot deliver those minimum net proceeds either because of size constraints or inability to underwrite, alternative structures such as those described below may be preferable.
As an alternative to an institutional placement and SPP structure, an issuer can make a pro-rata offer to all shareholders. The NZX Listing Rules provide for two forms of pro-rata offers without the need for approval by shareholders4:
Accelerated offers: Under this structure, institutional shareholders are offered their pro-rata entitlement over a very short period following launch of the offer, with the offer to retail shareholders of their pro-rata entitlement following immediately after the institutional offer. The benefit of "accelerating" the institutional offer is that the risk period for the institutional offer only lasts a number of days. This means that the institutional offer component has a risk period equivalent to that of a placement, but without the 25% limit on the proceeds that can be raised. For that reason, we expect accelerated offers will be the offer structure of choice if an institutional placement and SPP will not deliver sufficient net proceeds for an issuer.
Renounceable / "traditional" offers: Under this structure, existing shareholders are offered "rights" to subscribe for new shares. These rights can be sold by shareholders prior to the commencement of the offer period, to deliver some value to those shareholders who decide not to participate in the offer. In most offer structures of this type, the rights are tradable on NZX. In some structures, the rights can only be transferred privately with a bookbuild being conducted following the offer as a means of potentially returning value to those shareholders not participating in the offer. All offer shares are issued at the same time, typically three to four weeks following launch. In the current environment, we expect that such a long period of risk may not be palatable to issuers, investors or underwriters. We expect that this offer structure will be less appealing as a result.
Types of accelerated offers: AREO vs ANREO
Most recent accelerated offers in New Zealand have taken the form of an "accelerated renounceable entitlement offer" (AREO). Under an AREO, entitlements not taken up by shareholders are offered for sale through one or more bookbuilds with any premium realised above the issue price under the bookbuild(s) being paid to those shareholders.
NZX Regulation issued a
Class Waiver and accompanying
Issuer Update on 26 March 2019 allowing issuers to carry out "accelerated non-renounceable entitlement offers" (ANREO).
The key distinction between an AREO and an ANREO is the effect on shareholders who are not entitled to – or decide not to – participate in the offer.
AREO: such shareholders may still receive value if the bookbuild(s) realise a premium in respect of their shares not taken up in the offer;
ANREO: such shareholders will be diluted and receive no value. If the ANREO offer price is deeply discounted to the market price, the dilutionary impact may be significant.
Benefits of the ANREO structure?
The use of ANREO structures should mitigate market and execution risk during periods of market volatility given that:
Since there is no way to receive value for entitlements that are not exercised, ANREOs also tend to maximise the incentive for shareholders to participate in the offer. For that reason, ANREOs have been prevalent in other jurisdictions, particularly Australia. For example, Ooh Media (an ASX-listed company) launched a placement and ANREO on 26 March 2020 to raise A$167 million at a 37% discount to market price. In New Zealand, Kathmandu launched a placement and ANREO on 1 April 2020 to raise NZ$207 million, at a 51% discount to market price.
Boards will need to balance the improved deal certainty provided by an ANREO against the expected dilutionary and value impact on shareholders if they do not participate in the offer. Shareholders will be faced with the stark choice of either participating in the offer or being significantly diluted if they elect not to participate. Shareholders located in offshore jurisdictions who are not provided with the opportunity to participate in the ANREO will also find themselves significantly diluted, without receiving any value.
ANREO and concurrent placement
A condition of the NZX waiver permitting ANREOs is that the ratio of shares offered must not be greater than two shares for each share held (that is, a "2 for 1" issue). The condition seeks to mitigate the potential for dilution of shareholders that elect not to participate or who are ineligible to participate. The downside of that condition is that an ANREO has a limit to the amount of capital that can be raised. This can be addressed (as seen in recent market offers) by conducting a concurrent placement with institutional component of the ANREO. Existing institutional investors and new investors are able to participate in the placement, and provide sub-underwriting support in relation to any offer shares not taken up by shareholders in the ANREO.
Participation by major shareholders
It may be that one or more major shareholders will be required to support an offer to ensure that it is successful, which will affect the extent of any underwriting requirements for the offer.
The NZX Listing Rules permit a major shareholder (10% plus holder) to participate in an accelerated pro-rata offer (including any shortfall shares offered under a bookbuild in the case of an AREO) without requiring shareholder approval, so long as directors provide a certification to NZX certifying that the major shareholder did not influence, and will not benefit from, the offer (among others things).
The Takeovers Panel made an
announcement on 27 March 2020 that it intends to grant a suite of temporary class exemptions from the Takeovers Code that will allow shareholders to make "creeping" increases as a result of allotments (including between the 20% to 50% control zone) provided that the increase is subject to a 10% cap. In addition:
shareholders will be allowed to underwrite pro-rata offers provided that any additional voting rights acquired above the 10% cap are not exercised and are sold within a 24-month period, or the increase is subsequently approved by shareholders; and
current class exemptions will be amended to extend sell-down periods for shareholders and professional underwriters to 24 months.
The relief provided under the NZX Listing Rules and the Takeovers Code will facilitate major shareholders participating in offers above their pro-rata entitlement, including through acting as sub-underwriters. Major shareholders who increase their holdings (for example through sub-underwriting) should be aware that no relief exists under the Overseas Investment Act if the shareholder is an overseas person but its ordinary business does not include underwriting or sub-underwriting.
Downside price protection mechanisms for retail shareholders
Given the current market volatility, NZX Regulation has issued a
Ruling under which ANREOs and AREOs will be able to include differentiated pricing in any retail entitlement offer. Under the ruling, it will be permissible for issuers to set a different price to be paid by retail participants to that paid by institutional participants, so long as that retail offer price is less than the price paid by institutional participants. This balances the playing field with SPPs. Similar relief may be required from the Australian regulators if an accelerated offer with differential pricing is offered by an NZ issuer to retail shareholders in Australia.
Given this potential price differential, it will be important for issuers to make it very clear that the determination of whether a shareholder was allocated to the institutional or retail offer was based on a number of factors and was done at the issuer's sole discretion.
Snapshot of the two main offer structures based on the current NZX relief:
Institutional placement and SPP
Accelerated entitlement offer
Funding certainty in relation to the institutional placement due to speed of execution and short risk period.
Easier to procure underwriting. Possible that the SPP is not underwritten.
Placement can be extended to new investors.
New adverse events arising following the announcement of the offer can be "priced-in" to the issue price paid by retail shareholders in the SPP.
Issue price will likely be at a tighter discount to market price.
Funding certainty in relation to the institutional component due to speed of execution and short risk period.
Can be extended to new investors via the bookbuilds in an AREO.
No restrictions on the amount that can be raised (subject to shareholder approval by special resolution being required if the cash proceeds exceed 50% of the gross assets of the company and ratio restriction ("2 for 1" maximum) under an ANREO).
New adverse events arising after the announcement of the offer can be "priced-in" to the issue price paid by retail shareholders if differential pricing is adopted.
Complies with Recommendation 8.4 of the NZX Corporate Governance Code which encourages pro-rata offer structures.
May not be able to raise sufficient proceeds given the maximum amount raised under the placement is capped at 25%.
"Unfair" to retail shareholders who will be diluted, although this is mitigated by a follow-on SPP (or pro-rata offer).
Once the 25% capacity has been used in any 12-month period, there is no further capacity to conduct a placement without shareholder approval.
There can be a degree of uncertainty about net proceeds that will be raised under an SPP.
Retail shareholders who do not participate in the SPP will be diluted (but likely to a lesser extent than in an accelerated entitlement offer) and will not receive any value.
Longer risk period for entire offer compared with placement.
Pricing typically at a deeper discount than placements.
Shareholders who do not participate will be diluted, and may receive value in an AREO, but will not receive any value in an ANREO.
More expensive and potentially harder to procure underwriting, unless only the institutional component is underwritten.
Alternative transaction structures
If there is too much uncertainty regarding a particular issuer's ability to raise capital via the public markets, alternative methods will need to be considered, which may lead to innovations in how issuers raise capital. For example, it may be that an issuer seeks a strategic investment by a private investor or private equity fund (a "PIPE" (private investment in public company) offering) pending a capital raising in the future. It may also be the case that the Crown looks to provide financial support in the form of a direct equity investment (or as an underwriter) in the case of issuers who are strategically significant to NZ Inc.
In addition to obtain advice regarding the choice of offer structure, some of the additional key considerations for a board will be:
Independent advice: The board could consider appointing independent advisers to the board, who will assist the board in its assessment of the advice being provided by underwriters regarding timing, structure, pricing and quantum of any capital raise.
Pricing: Pricing will be particularly difficult given the market volatility. If an issuer elects to use a placement or SPP and the issue price discount is greater than 15% of the market price, the NZX Listing Rules require the board to certify that the price is fair and reasonable to the issuer and those shareholders not participating in the offer.
How much should be raised? The board will need to consider the potential effects of COVID-19 at various levels of severity, including through stress testing the business's need for capital in a worst case scenario. Even when come the issuer comes out of lockdown, it may be very hard to predict how quickly a business can re-establish itself.
Do we satisfy the legal conditions to raise capital? We expect that most issuers would rely on the “same class of quoted financial products" exemption under the Financial Markets Conduct Act 2013. If so, the issuer will be required to publish a cleansing notice confirm that (i) it is complying with its continuous disclosure obligations under the NZX Listing Rules and its financial reporting obligations; and (ii) it does not hold any "excluded information", being price sensitive information that has not been disclosed to the market in reliance on a permitted exception. The board will need to carefully assess whether it is in a position to provide those confirmations. As noted in our previous
publication, this will require careful consideration, particularly if there is an imperfect information set regarding the extent and duration of any negative impacts on the business from COVID-19. Throughout the offer period the issuer will not be able to withhold any material information in reliance upon an exception to disclosure.
How do we obtain funding certainty? Funding certainty will come in the form of underwriting and major shareholder commitments. However, underwriters and major shareholders will want to know that the business is fundamentally sound and may want information regarding the financial impact that is not available. We expect that there will be sharp focus by underwriters on their termination rights.
When is the right time to raise capital? One of the lessons of the GFC is that it is better not to leave it too late to raise equity. It may make sense to be well-prepared when the markets do open.
Adequacy of disclosure? There will be difficult judgements to be made relating to risks and challenging disclosures regarding the extent of any impact of COVID-19 on the outlook for the business and whether the cash being raised will be sufficient when there remains uncertainty around the duration and extent of the impact. This disclosure will be more acute if the company has published earnings guidance that has not yet been updated. We expect that there will be more detailed risk factors included in the offer materials. Also, where revised earnings guidance has been provided, the assumptions relating to COVID-19 underpinning that guidance should be discussed – that is, how long is it assumed that New Zealand will be in Alert Level 4? The listed issuer will need to continuously update the market during the offer period in respect of any new material information, so the SPP and accelerated offer structures that allow the issue price paid by retail shareholders to price in a material adverse event following launch provide some scope for the board to allow an offer to continue even in such circumstances.
What preparatory steps should we be taking? Our advice is for listed issuers to get organised ahead of time so that they are not rushed prior to the launch of an offer. Once the uncertainty stops, markets may bounce back quicker than in the GFC so a number of preparatory steps could be taken now, including:
starting the process to assess whether the company is in compliance with its continuous disclosure and financial reporting obligations and to identify what price sensitive information has not been disclosed to the market in reliance on a permitted exception,
encouraging shareholders to opt-in to e-communications,
engaging early with an investment bank and other advisers,
calculating the current placement capacity that remains available for use, and
considering the introduction of a dividend reinvestment plan.
What due diligence enquiries should be undertaken prior to the capital raising? The liability for an issuer and its directors in respect of any offering materials for a placement or shareholder offer is theoretically no different to any other public release by the company. However, there is heightened sensitivity when raising capital from investors. We recommend that a robust yet streamlined due diligence process is conducted. The preparatory time will not be materially different for the various types of offer structure. There is no reason why a due diligence process that meets market best practice standards cannot be undertaken while all participants are working from home.
What happens if the situation worsens during the offer period? Throughout the offer period, the issuer will be required to comply with its continuous disclosure obligations and update the market with any price sensitive information, without being able to withhold disclosure in reliance upon an exception to disclosure. It may therefore be possible to address any new adverse matter or circumstance through disclosure without having to withdraw the offer, subject to any termination rights that the underwriters may exercise.
A capital raising in the current environment will be possible, and can provide rapid access to capital provided the various structural and other considerations raised above can be appropriately navigated. We recommend that issuers start working through those considerations now, so that they can act decisively when they, and the markets, are ready.
If you have any questions about the matters raised in this article please get in touch with the contacts listed, or your usual Bell Gully adviser.
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This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.