Rights and Wrongs

Companies hit by the credit crunch shouldn't be shy about going down the rights-issue route.

Ever since credit markets seized up last summer, market watchers have nervously scanned the corporate landscape for signs that the turmoil is spreading beyond the financial-services industry. UK-based oil-exploration company Imperial Energy may be the proverbial canary in the coal mine.

Last month, the firm announced a hitch in its plans to refinance a $200m (€125m) loan facility that matures in November. “The current state of the debt markets,” the company said, “provides a significantly more challenging environment to raise debt finance on terms acceptable to the company.” Instead, Imperial Energy plans to raise $600m via a deeply discounted rights issue. The company’s shares promptly lost 30% of their value on the day of the announcement.

The longer the credit crunch rumbles on, the more non-financial companies it will ensnare as their credit facilities fall due, notes Allen Blewitt, chief executive of the Association of Chartered Certified Accountants (ACCA). For the routine credit lines that most of the ACCA’s corporate members “used to take for granted,” he’s urging them to get loan terms “absolutely negotiated and locked down” now, lest they be forced, like Imperial Energy, to resort to more drastic capital-raising measures.

It may already be too late, note Graham Secker and Charlotte Swing, two analysts at Morgan Stanley. “If the old paradigm was de-equitisation, the new paradigm is re-equitisation,” they write in a recent report. Between 2003 and 2007, companies gorged themselves on cheap debt and bought back huge swathes of their own shares. In the UK, for example, shareholders’ equity as a percentage of total assets now stands at a 20-year low, regardless of whether financial services companies are included or not.

Given the recent increase in the cost of debt relative to equity, the analysts expect “a sharp rise in companies tapping equity investors for cash,” as in 2001 and 2002, when a “fall in the cost of equity funding, relative to debt funding, prompted a sharp increase in rights issues.”

If a company decides to go down the rights-issue route, it’s best not to be shy about it. Of the more than 100 rights issues studied by Morgan Stanley’s analysts over the past ten years, the share price of companies that raised cash worth at least 50% of their market capitalisation subsequently outperformed peers over the next two years. For the beleaguered shareholders of Imperial Energy — whose rights issue will raise cash worth around half of its pre-announcement market capitalisation — this may offer some comfort.

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