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WHEN A DEAL STRUCTURED IS FOR ‘ME, MYSELF AND I’

06 December 2014

Let's face it, when companies come to the capital markets, it is only because they need capital from other investors or it is because they want to realise value.

Companies who need capital tend to sugar-coat their normal behaviour patterns, and will generally show the side which emphasises that their corporate actions are to benefit all investors and the company as a whole. However, the selfish side will emerge when a larger shareholder wants his way. The issue of how much you own, matters most when you want something. Time and time again, those investors or shareholders who have a big stake in a company often push through deals or changes that they want at the expense of smaller shareholders. Nothing new and often a very painful experience.

One hot topic in the capital markets is always around the issue of “related party transactions”. One would assume that if a company has raised capital for its activities from the market, then it should have no choice really but to play by the rules. However, all too often, it is those same main shareholders who will attempt to make all sorts of changes to a company without giving its minority shareholders a say – if at all.

We witnessed one such instance recently by a significant shareholder who decided to assert total control over its company. A public-listed company currently controlled by a large family via an investment vehicle, announced that it was going for a massive rights issue. This issue would be on a ratio of six-for-one. The proposed rights issue represented 85% of the fully diluted share capital of this company. But the most glaring part of this exercise was that the price offered for the rights issue was at a significant discount of 60%.

The company stated this rights issue was meant to increase its paid-up capital, which would allow the company to buy new assets from another company. Now, the flaming red flag about the proposed purchase was that these “new” assets were put up for sale by one of the existing investors in the company itself. In fact, that investor owned about 20% of the company via three different investment vehicles.

The company’s minority shareholders, understandably, kicked up a fuss about the proposed purchase. They cited the following reasons for their opposition to the deal:

> The proposed rights issue to enable the acquisition of this substantial shareholder’s assets would likely erode the company’s value because its capital would be enlarged only at a huge discount;

> The company would be buying these assets at a price before the rights issue; the company’s share price had since fallen on news of the proposed rights issue; and

> The substantial shareholder, who intended to sell his assets to the company, was going to assume control of the company via a reverse takeover.

Surprise, surprise but the substantial shareholder had entered into an agreement with the company to take up nearly all of its rights. As a result of this agreement, the rest of the company’s shareholders would have their stakes in the company diluted down to a mere 5%, while the substantial shareholder in question would end up with more than 50% of the company’s shares, after the proposed massive rights issue.

Now, when you consider that the proposed massive rights issue would turn the substantial shareholder into a controlling one, and that the proceeds from the rights issue would be used to buy assets belonging to the substantial shareholder, most investors would expect, rightly, that the substantial shareholder would be barred from voting at the company’s EGM. The EGM is being called to seek approval from shareholders for the rights issue and it seems clear that a vote by the substantial shareholder on the rights issue would be a clear instance of a conflict of interest.

Related transaction

What is especially interesting about this is that, when we scrutinised the industry’s review of this exercise, we found that most analysts seemed to have completely overlooked the fact that this proposed rights issue was a related transaction. The analysts seem to be neither concerned about the pricing of the rights issue nor the substantial shareholder’s insistence and ability to vote for it.

What the analysts did focus on were other key risks such as:

> The possibility that the company would not be able to achieve synergies due to having far more assets in the near future, at a time of lower prices for its products.

> The end game is a bigger asset base for the company; not that it was really an inappropriate structured deal.

The more astute investor would, however, quite quickly assess the wisdom of this potential investment, the issue of how dilutive the rights issue is and the likely conflict of interest from buying assets from one’s substantial shareholder.

As this issue got from bad to worse, the company was suspended from trading in the market. The halt in trading was aimed at giving other market players sufficient time to think through thoroughly their plans. Perhaps a better idea would have been to offer a more balanced alternative to all shareholders, not this “one size should fit all”.




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