Alan Kohler
Speed dating for desperados
The Australian sharemarket has produced about $50 billion in new capital for listed companies this year.
This seems like a great achievement in the circumstances, a demonstration of the inherent vigour of the capital system: the market is down nearly 50 per cent and remains in a complete funk, yet companies that need capital have still been able get it.
Actually, it’s more like something out of Underbelly, or perhaps speed dating for desperados. Triple dating in fact. Boards are desperate, investment bankers are desperate and fund managers are desperate.
About once a week they come together and couple in a dark and lurching frenzy, and scuttle off counting the cash. But it’s the shareholders who get screwed.
The common method of raising capital these days is through a discounted placement to institutions. The board and the CFO get the usual investment banker in, they agree on the discount and the fee (usually 2 per cent), the investment banker looks out the window and quietly pushes the “standard underwriting agreement” across the desk to be signed, the company secretary is despatched to request a trading halt and the Equity Capital Markets sales staff of the investment bank hit the phones the next morning.
The best clients, of course, get called first and eventually the tired and hoarse ECM phone jockeys get to the lesser clients around 9am. The bids are due in by midday.
The fund managers have to make a quick decision based on no new information or promises. The company’s board and management do not disclose in detail what they plan to do with the cash and do not make any forecasts about what return they intend to make on the funds.
Fund managers are no position to make a sensible investment decision on the placement and the issuing company and its investment bank are relying on the fact that they can’t afford not to be in it.
When a Morgan Stanley sales person says you’ve got three hours to bid for, say, Westpac at a discount of 10.5 per cent, or Bluescope at a discount of 23 per cent to the market, what are you going to do? You’re going to bid.
The funds are overflowing with cash at a time when cash returns are plummeting. Any opportunity to buy stocks in large lumps at a discount to the market must be taken, even if it’s in a high-pressure, low information environment.
But the biggest scandal is that the investment banks are getting 2 per cent to take the orders. Across the $50 billion or so in capital raisings this year, that means $1 billion has been paid to investment banks – and a billion dollars is something they seriously needed.
It is described as an underwriting fee, but that’s in name only.
In the old days, underwriting fees used to be paid for the risk that the broker or bank was taking with its balance sheet by guaranteeing to pay the money if the market did not provide it.
Now the 'underwriting agreements' have such wide ranging and easily triggered “out clauses” that the slightest change in market conditions would mean that the 'underwriter' would not have to pay.
Nowadays the underwriting fee is more like a pay-off to a stand-over man. Companies are, in effect, paying the investment banks to lean on the fund managers and extort money from them.
Small shareholders simply get diluted; 'institutions' get to throw good money after bad, investing at a discount without any promises or even information in companies in which they have already lost a great fortune.
It’s a wild and crazy system, but it just might be working. Desperate boards are paying desperate investment banks to extract money from desperate fund managers.
These are desperate times.
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