Lyndon Johnson, the US president, famously said: "If you've got them by the balls, their hearts and minds will follow." This is the theory of so-called "deep discount" rights issues. If your shares are trading at X, and you decide to raise money by giving your shareholders the right to buy shares at half of X, then the only way the investors can avoid losing their shirts is to take up their rights.
So it is with Royal & SunAlliance. The troubled insurer needed a short £1bn to shore up its balance sheet. So it launched a one-for-one rights issue at 70p when its shares were 154p. Do the maths (154p plus 70p divided by two) and you will find that the theoretical value of RSA shares fell to 112p overnight. The shares ended the week at 128p, so you would expect every shareholder to divvy up their 70p.
If everyone is going to take up their rights, then surely you do not need the share issue to be underwritten. This is when you pay the fine folk in the City lots of money (£35m in RSA's case) to say they will stand in the market and buy any shares that are not taken up.
Three investment banks performed this task: Merrill Lynch, Cazenove and Goldman Sachs (which, some of us remember, contributed to RSA's dilemma by making such a hash of selling the company's life business a couple of years ago). They then sub-underwrite - getting institutional investors to pledge to take spare shares.
The institutions were so keen on this share issue that the sub-underwriting was three times oversubscribed.
There could be a number of reasons for this. First, optimism about the economy and the prospects for RSA. Second, a shortage of RSA shares in the UK market, because over a third of its shares are held by US funds, many of whom are hedge funds buying in the hope that RSA is about to be taken over. Third, the shares were priced far too cheaply. All of this is true, especially the third point. It seems that the RSA rights issue was priced as if it were not being underwritten, yet was underwritten anyway. This is the belt-and-braces approach to fundraising, which would be fine if it did not give the City a £35m free ride at the expense of RSA's long-suffering investors.
RSA said it was concerned that, as it had a lot of hedge funds on its shareholder register, a lot of them might not take up their rights. Well, this makes little sense. And it makes little sense for two reasons.
First, hedge funds are not in the business of losing money. And for the reasons I explained earlier, you have to be either hard up or stupid not to take up your rights in a deep discount share issue.
Second, four shareholders own more than 30 per cent of RSA's stock: US investor FMR has nearly 10 per cent, the Californian fund Brandes nearly 9 per cent, the investment giant Fidelity 7.5 per cent, and Barclays Global Investors 4 per cent. None is a hedge fund. All could be asked quite quickly if they were taking up their rights, at a cost of a darn sight less than £35m.
The truth, I suspect, is that RSA was so desperate to shore up its balance sheet that the City had it by the balls. Its heart and its wallet had to follow.
Attila the stockbroker
I've known Terry Smith for 15 years and, though I like him, he is an aggressive so-and-so. His reactions to the accusations against his stockbroking firm, Collins Stewart, show this. He accused his accuser of blackmail, a charge rejected by the Crown Prosecution Service, and sued the Financial Times for libel because it repeated the accusations.
The FT has to defend itself and the only way it can win, given the onerous burden of proof in libel, is for the Financial Services Authority to find against Collins Stewart. But neither side should hold its breath.
I understand that the FSA's investigation division is tied up with the split capital trust probe and has little time and few resources to devote to the Collins Stewart accusations. The regulator is never the speediest of bodies, so I fear it could be a good couple of years before we know the answer in this case.Reuse content