More companies expected to undertake rights issues this year

This article first appeared in The Edge Malaysia Weekly, on February 11, 2019 - February 17, 2019.
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AS the economic outlook for the next 12 months gets cloudier, and with major industries still facing uncertainties and difficulties, more companies listed on Bursa Malaysia are expected to tap their major shareholders’ pockets to stabilise their financials.

Corporate finance advisers and investment bankers believe that economic headwinds will affect industries across the board, and that companies with weak balance sheets and substantially high gearing would be hit the hardest.

“It is a matter of who gets hit harder. Companies that have substantially higher gearing than normal and weak corporate finances will be hit the hardest, hence recapitalisation could be necessary,” Astramina Advisory managing director Wong Muh Rong says in a written reply to The Edge’s questions.

Last year, Bursa-listed companies raised a total of RM6.9 billion through the issuance of rights shares, according to Bloomberg. This value does not include private placements, which could add another RM3 billion to the tally.

In 2017, companies listed on Bursa raised RM9.7 billion through rights issues.

Looking at the economic environment, industries that could be hit the hardest include oil and gas services, plantation and property development. Companies in these industries with weak balance sheets will need to bank on their shareholders in the near future.

According to Ramesh Manimekalanandan, regional head of equity capital markets at Maybank Kim Eng, fundraising — whether through a rights issue or private placement — is typically driven by the need to strengthen a company’s balance sheet.

Funds could also be raised in the event of mergers and acquisitions (M&A), whereby the acquiring party could ask its shareholders to fund the exercise, he says.

“We saw this with financial institutions ahead of regulatory requirements and the impact of IFRS 9, whereby such institutions sought to raise capital for business growth. We saw this again with oil and gas services providers, where the prolonged challenges across the industry resulted in their capital base being eroded, and fresh capital was required to start growing the business again.

“We believe the plantation sector may be affected by prolonged margin compression arising from CPO (crude palm oil) weakness, which may trigger consolidation. The acquiring party may opt for fundraising via a rights issue should activities in the space pick up as expected,” says Ramesh.

He notes that the trend of raising funds via rights issues to finance M&A could also be seen among domestic property players, given the level of unsold inventory build-up, which puts a strain on their working capital availability.

But are rights issues the best way for companies to recapitalise? Is fundraising in the form of equity issuance to either existing or new shareholders the best avenue for companies to raise funds rather than tapping the debt market or bank borrowings?

According to Astramina’s Wong, in an economic slowdown or downturn, when banks are cautious and do not have the appetite to lend money, equity fundraising is the best instrument for companies to recapitalise or reduce their debt level to save on financing rates.

Equity fundraising, such as rights issues, also signal the major shareholders’ commitment to, and confidence in, the company as they are the ones who would be forking out a huge amount to finance the undertaking, she says.

“For me, if a substantial shareholder commits to a rights issue or something similar, minority shareholders should follow suit, especially if the substantial shareholder is committed to subscribing for more than what is required — it is a sign of the confidence level of an existing substantial shareholder.”

Lacklustre share price movement

While rights issues could be the best way for companies to raise funds in an economic downturn, it would mean that major shareholders would have to make a bigger commitment to the companies, regardless of their future returns and performance.

For example, Sapura Energy Bhd’s shares closed at 28 sen apiece on Feb 8, which was 6.7% lower than its rights issue price of 30 sen per share. Since the announcement of the RM4 billion cash call programme on Dec 17 last year, the counter has lost 16.4% in value.

This is despite the company securing jobs amounting to RM9.3 billion so far in financial year 2019, which can sustain its operations for the next three years, as well as forming an upstream joint venture with OMV AG, an Austrian oil and gas services provider.

To be fair, the oil and gas industry is still reeling from the low crude oil price, which caps exploration and production (E&P) spending by major oil and gas companies, while the trade war between the US and China could lower global economic growth as investors and purchasing managers put off their plans.

It has also been just a few days since the rights shares were listed on Jan 29.

However, the fact that Sapura Energy’s rights issuance was 18.5% undersubscribed could mean limited potential upside for its share price, as there are 1.8 billion shares now held by underwriters Maybank Investment Bank, CIMB Investment Bank and RHB Investment Bank.

“Even though our earnings forecasts are unchanged on positive order book prospects, the overhang of underwritten shares from the undersubscribed rights portion will limit any potential upside over the medium term,” Alex Goh, an analyst at AmInvestment Bank, says in a Jan 24 report.

Goh estimates that the underwriters may need a few months to dispose of unsubscribed shares upon their listing on Jan 29, given Sapura Energy’s average daily trading volume of 116 million shares over the last 12 months.

The cash call programme had turned Permodalan Nasional Bhd (PNB) into Sapura Energy’s largest shareholder, taking over from Tan Sri Shahril Shamsuddin. As at Jan 31, the asset management fund held a 40% stake in Sapura Energy, while Shahril’s Sapura Holdings Sdn Bhd held 16.57%.

It might take some time and more good news from Sapura Energy for its share price to move up and benefit PNB’s Amanah Saham Bumiputera, which has thrown the group a lifeline by subscribing for 3.9 billion shares in the cash call exercise.

Nevertheless, PNB is confident of its investment in Sapura Energy. The fund said it gave its support to Sapura Energy’s fundraising exercise due to the arrangement for the group to restructure its debts and businesses.

“When supporting any rights issue for the purpose of recapitalisation of the investee company, PNB always imposes stringent conditions on the company concerned to ensure it is undertaken as part of a comprehensive restructuring plan that will deliver sustainable long-term value to shareholders,” the fund says in a written reply to The Edge’s questions

“In the case of Sapura Energy, PNB’s support was given following an arrangement for the company to undertake a restructuring exercise, to secure partnerships for its E&P and drilling businesses, to develop a clear plan to reduce its debt significantly and to undertake specific measures to improve its governance, and management of its compensation.

“Encouraging progress is already evident and there has been an increasing number of contract wins. The group’s contract wins to date in FY2019 stands at RM9.3 billion for its engineering, construction and drilling businesses,” it adds.

Besides its investment in Sapura Energy, PNB is also the largest shareholder of Velesto Energy Bhd, an oil and gas services provider that had also tapped the fund through the issuance of rights shares. PNB subscribed for 2.7 billion Velesto rights shares at 30 sen apiece in September 2017.

As at last Friday, Velesto was trading at 19.5 sen per share, or 35% lower than the price of the rights shares subscribed by PNB.

Despite the still lacklustre share price performance of Velesto, PNB says the results from its debt reduction and cost rationalisation exercise have been impactful, with net debt reduced by RM3.2 billion to RM1.2 billion, translating into a much more sustainable net gearing ratio of 0.4 times.

“The company is now generating strong positive Ebitda (earnings before interest, taxes, depreciation and amortisation) and is close to breaking even and on track to achieve profitability in the coming year, in a more stable environment for the O&G industry,” the fund says.

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