Prism's ratchet to riches takes some beating: Comment

Prism Rail's founding investors like to call the extraordinary money-making wheeze they had built into the company's articles of association a "ratchet scheme". The rest of us will continue to think of it as a racket. Not that it can be faulted, except perhaps as an example of unbridled corporate excess. It is not illegal; nor, given that it is set out in black and white in Prism's original flotation prospectus, can it be regarded as even remotely questionable. But as an example of how to use the stock market to enrich yourself beyond the dreams of avarice it takes some beating.

Prism Rail is a stock market vehicle set up by a group of successful bus operators specifically for the purpose of bidding for privatised rail franchises. It has proved a wonder stock, rising fivefold since being floated on the Alternative Investment Market last May. What the founding investors did was grant themselves a lorry load of "free" deferred shares, which become convertible into ordinary shares every time they raise money to finance a rail franchise. This is justified on the basis that the founders put up pounds 2.7m of their own money to cover the costs of tendering for the franchises, none of which is refundable should they fail. Perhaps predictably, they haven't. Prism won its fourth franchise yesterday - the West Anglia Great Northern - and duly announced proposals to raise pounds 12m to finance it.

This is where the wheeze gets really clever ... er, sorry, astute. The conversion rate for the founders is one free share for every four shares issued. So does that mean the founders get free shares to the value of 25 per cent of the money raised? Don't be naive. The rights issue has been pitched at a deep discount to the current stock market price.

Thus for just pounds 12m raised, the founders get pounds 5.4m of worth of free shares. The deeper the discount, the more the founders get as a proportion of the amount raised. Add in the underwriting fee of an astonishing 3.5 per cent, most of which goes to Williams de Broe (this on a deeply discounted rights, but when there's so much money flying around it's only fair to share it out a bit), and you are looking at a cost of capital of something approaching 50 per cent. Even in the weird and wacky world of venture capital, that's going it.

If these franchises turn out to be the gold mine Williams de Broe and others think they are, then nobody's going to complain. But for ratchet should we perhaps be reading Ponzi? Just watch it.