In this article, which was published in the Mining Journal on April 5, 2013, BLP partner Alexander Keepin and Associate Brian Mulkerrins, outline the key considerations for mining companies when thinking about rights issues.
Earlier this month Talvivaara Mining Company Plc announced the terms of a proposed rights issue to raise gross proceeds of EUR 261 million. This entitles shareholders to subscribe for six new shares in Talvivaara for each existing share held by that shareholder on the record date, 13 March 2013 at a subscription price of EUR 0.16 per new share. The subscription price represents, in effect an 84.5 per cent discount to the closing price of an existing share and a 43.7 per cent discount to the theoretical ex-rights price (TERP) of an existing share.
The Talvivaara rights issue follows Ophir Energy PLC’s announcement of a rights issue and continues a theme in 2013 of companies raising capital in this way. In 2012, over ten UK-listed companies announced rights issues, including Lonmin Plc and Pan African Resources PLC. Four rights issues have already been announced this year by UK-listed companies over a two-week period which suggests that rights issues will be an important source of finance for companies this year, perhaps even touching the levels seen in 2008.
What is a rights issue?
The essential aspects of a rights issue are:
- an offer of new shares;
- shareholders subscribe in proportion to their holdings;
- the subscription price is nearly always at a discount to the market place;
- the shareholder has the ability to realise the value of some or all of its rights to subscribe for the new shares by selling them in the market nil paid (and may even sell some rights to take up the remainder – a process known as tail swallowing); and
- even if the shareholder does nothing, he has the right to receive any value over and above the subscription price as long as the shares that he could have taken up are sold in the market by the underwriter at a premium to the subscription price, plus associated costs.
The most common reasons for rights issues are either for refinancing, such as repaying debt or funding working capital, or to finance an acquisition or development.
By way of example, Talvivaara stated that the proceeds of its rights issue will be applied to refinance the company and to secure liquidity for its continued ramp-up of operations towards full capacity. The proceeds will also enable refinancing or repayment of short-term and medium-term indebtedness, including the convertible bonds due in May 2013 and to satisfy a condition subsequent under an amended revolving credit facility.
Underwriting and Underwriting fees
Companies typically choose to have their rights issues underwritten to guarantee that a specific level of funds will be raised. The role of the underwriter is to guarantee that the amount required from the share issue will be raised. If necessary the underwriter will purchase the new shares in the event that existing shareholders are unwilling or unable to take up their entitlements.
In the Talvivaara rights issue, shareholders holding in aggregate 38.3% of the existing issued share capital in the company have irrevocably committed to take up their entitlements. The Talvivaara rights issue is being underwritten, by a syndicate of investment banks, except for to those shares that are subject to shareholder irrevocable commitments.
In exchange for the underwriting commitment, the underwriter receives a fee calculated as a percentage of the proceeds of the rights issue which it underwrites or in some cases the gross proceeds. The question of underwriting fees and transparency of those fees has come under a certain amount of scrutiny in recent years by both the Office of Fair Trading (OFT) and investor bodies such as the Institutional Investor Council (IIC)
On 27 January 2011, the OFT undertook a study of the market for equity underwriting and associated services. The OFT found that between 2000 and 2010, mean underwriting commissions were broadly stable during the early part of the period (at around 2-2.5% between 2003 and 2007) and a pronounced increase was seen in 2008 and 2009, with mean fees over 3% in 2009.
As market volatility increased significantly in late 2008, the OFT stated that it was not surprising that fees also rose to reflect the increased risk that equity underwriters faced at that time due to turbulent stock market conditions. However, fees are still typically 3% although this may in part be to continued volatility and difficulties in raising funds in the equity markets.
Similar to the OFT study, on 14 December 2010, the IIC published a report on rights issues and set out recommendations in the key areas of transparency, competition and shareholder involvement including that companies should, wherever possible, put the primary underwriting contract out to tender.
The IIC further stated that there should be no automatic assumption that rights issues should be fully underwritten. Issuers should decide what proportion of the issue should be underwritten, by whom (for example, in part by substantial shareholders in the Talvivaara rights issues) and at what price.
For most of the period 2000 to 2010, discounts varied significantly between rights issues, with traditionally rescue rights issues requiring a deeper discount than rights issues to make an acquisition. However, the OFT found that, in 2009, discounts became clustered at around 40% (from a previous norm of about 30%). As the underwriter may be obliged to subscribe for the new shares, the effect, among other things, of a deep discount is to reduce the exposure of the underwriter. As with underwriting fees, discounts are still high by historical standards, currently typically ranging between 30% and 50%, and even higher in the case of the Talvivaara rights issue.
Changes to facilitate rights issues
Following recommendations by the Rights Issue Review Group (RIRG) in November 2008, certain legal and regulatory changes have also been madeover the last couple of years, which have made it easier for companies to undertake rights issues.
These changes have reduced the time in which a rights issue can be completed by amending the Companies Act 2006 to shorten the statutory right issue period from 21 to 14 days, shortening the notice period for general meetings from 21 to 14 clear days, and amending the Admission and Disclosure Standards of the London Stock Exchange and the AIM Rules to shorten the minimum duration of open offers from 15 to 10 business days.
Changes have also been made to increase the annual authority to allot shares pursuant to a rights issue to two thirds of an issuer’s share capital, a move supported by shareholder groups such as the Association of British Insurers.
Additionally, on 1 July 2012, the UK implemented amendments to the Prospectus Directive, which include a proportionate, lighter, disclosure regime for rights issue prospectuses.
The cumulative effect of these changes is to allow companies to make rights issues quicker and easier which may also have contributed to the increase in popularity of rights issues.
Rights issues are being used to refinance companies and to provide acquisition finance, a trend which is likely to continue this year. However whilst companies looking to use rights issues may benefit from the recent legal and regulatory changes, as a matter of good governance, boards should scrutinise the role of the underwriter and the fees paid.