Jeremy Warner: Wolseley makes case for rights issue queue

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The Independent Online

Outlook: Bring back the "rights issue queue". The cry has gone up anew following the spectacle of Wolseley's £1bn share issue. The present glut of distress rights issues has forced the UK-based building supplies company into the most extraordinary contortions to secure desperately needed new equity funding.

Up until 1989, companies wishing to tap the markets for new equity were forced to notify the authorities and take their place in an orderly queue determined by the Bank of England according to what quantities of money it believed were available to invest and which companies it thought needed the money most. You had to wait your turn.

In truth, it was a relatively informal mechanism which was operated by the Bank in a reasonably fair and equitable fashion. When applying for permission to raise funds, officials would consult a book, and if things were looking particularly busy, or there was heavy gilts issuance that week, you were asked whether you would mind awfully putting it off for a while.

It was harmless, even mildly helpful stuff, but that didn't stop companies and their advisers claiming they had been disadvantaged and the whole thing was a gross invasion of free-market principles. In the spirit of deregulation, it was eventually abandoned.

Yet its time may have come again, with every man and his dog desperately trying to replace debt with equity. The markets are finding it impossible to cope with the resulting pile-up. Nearly £30bn of rights issues and share placements have been announced in the UK market this year, with the greatest concentration of fund-raising occurring in late March and early April. The record-breaking £12.5bn rights issue announced by HSBC this week, which wasn't widely expected, has crowded out everyone else.

And by all accounts there is a veritable tsunami of others coming up the rear. Add in the $10bn to $20bn investors are said to be gagging to put up for Rio Tinto (believe it if you will), and we are talking very serious money indeed. The alternative fund-raising the Rio board has negotiated with Chinalco may be unpalatable to some shareholders, but the reality is Rio will struggle to sub-underwrite a rights issue of the necessary magnitude in these markets. The pool of available sub-underwriters has been expanded in recent years by the addition of hedge funds and corporate lenders, but both are now in ragged retreat.

There are just a whole lot fewer hedge funds than there used to be, while many lenders have discovered to their cost that during a bear market sub-underwriting even a deeply discounted rights issue is not the money for old rope it used to be. Quite a few rights issues have been left with the underwriters over the last year, leaving participants facing substantial losses that dwarf any fees received.

Most sub-underwriting is traditionally undertaken by the issuer's own shareholders in a process sometimes known as "standing your corner". Big institutional investors will agree to take up their pro-rata share of the rights plus a bit on top. Yet there have been so many of them of late, that even those shareholders who still have the money are beginning to tire of standing their corner. It's partly fatigue, but it's also lack of the readies. Those companies that leave it too late might not manage it at all.

One of the problems Wolseley has encountered is that around 30 per cent of its shareholders are based in the US, where you are not allowed to participate in sub-underwriting. So even before the abnormally heavy issuance of the past week, it was facing a deficit of underwriting capacity.

I'm not going to bore you with the detail of how the investment bankers have managed to circumvent these constraints; suffice it to say that it fair makes the head spin. A big chunk of money is being raised in a straight placing, which, though it infringes the principle of pre-emption rights, was in practice the only way of securing American participation. Then the shares are divided and consolidated, culminating in a rights issue of a size which could be underwritten.

Get it? Oh, never mind. The point is that when it's about survival, the niceties of pre-emption rights go out the door. But if the queuing system had still been in place, Wolseley might not have needed to go down this route. As for Wolseley itself, there's a good business in there somewhere, but with the virtually cessation of housebuilding in the US and Europe, there is for now no demand for it. In the US, there is a two-year supply of finished but unsold housing stock. Shareholders may have a long wait before their company returns to the dividend lists.

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