Rights issues and investment mandates

By Will Moncrieff.

Key Points:
A major shareholder can underwrite a rights issue, provided safeguards are put in place.

Rights issues continue to be a problem area for companies.

In the August M&A Insights, I discussed the Takeover Panel's intervention in the InvestorInfo rights issue. Subsequently, Emperor Mines found itself before the Panel when it tried to raise some much-needed cash through an underwritten issue.

Emperor eventually got the green light, but only after some detailed probing. The main lesson to emerge is that a "second round" shareholder participation facility is absolutely essential if a non-renounceable rights issue is to be underwritten by a major shareholder. A subsidiary issue - and perhaps more problematic - is whether existing shareholders are actually able to take up their rights.

The need for money

Emperor Mines needed money and proposed a 4-for-10 non-renounceable rights issue, underwritten by 45% shareholder Durban Roodepoort Deep (DRD). The rights issue included a shortfall facility, under which shareholders (including the underwriter) could apply for any rights that hadn't been taken up in the initial offer. If insufficient shareholders took up their rights, the rights issue could result in DRD moving to over 50% control.

A number of shareholders had problems with this. They advised the Panel that their holdings in Emperor were subject to investment mandates. Those mandates would prevent their participating in the rights issue if DRD ended up with over 50% of Emperor.

The original sitting Panel in the initial Emperor Mines 01 proceedings made a declaration of unacceptable circumstances.

This first Panel decision was subjected to a review, with the Review Panel receiving further submissions:

• about Emperor's need for cash; and
• from the shareholder applicants to the effect that they were now considering whether or not to take up their rights.

The Review Panel overturned the original decision. The Review Panel noted that modifications had been made to the shortfall facility whereby the underwriting shareholder would not participate in the shortfall facility until all other shareholders' applications had been satisfied.

In the eyes of the Review Panel, this put the ball back in the complainant shareholders' court. The change to the shortfall facility meant that there was a chance that all of the rights would be taken up by shareholders, so that none would fall through to the underwriter. If that happened, the underwriter would remain at 45%. However, as the Review Panel pointed out, this was a matter within the control of the complainant shareholders:

"[T]he level of any increase in voting power by DRD as a result of underwriting the rights issue was in the hands of those… shareholders, to the extent that they were financially willing to do so."

The rights of shareholders

The Review Panel clearly recognised that sometimes only a major shareholder is willing to put up the cash needed by a company. A shortfall facility provides a simple mechanism to verify that no other shareholder has the ability or the willingness to come to the party.

Notwithstanding this positive picture, some commentators have suggested that the Emperor Mines decision imposes unfortunate new obligations on companies.

Particularly significant in this respect is the fact that both the Initial and the Review Panels took account of the complaining shareholders' investment mandates. Potentially, this raises some worrying concerns for companies. For example, is it appropriate that a company's capital-raising exercise be preceded by a poll or inquiry of shareholders to ensure that no shareholders have self-imposed restrictions that would impact on their participation in the exercise?

This could be problematic for listed companies. Discussing capital management plans with a wide range of shareholders simply increases the chance of an information leak. Because of the continuous disclosure rules, the leaking of information could force a company to disclose its plans before they were finalised.

What if a company announces a business proposal and is then told by a group of shareholders that the proposal impacts adversely on those shareholders? After the Panel's decision in this case, should a company consider entering into negotiations with the shareholders, rather than facing the prospect of an application to the Panel?

Finally, there's the question of exactly what type of shareholder interests might the Panel seek to protect. It's quite possible to envisage a variation on the situation in this case. If a listed company announced a rights issue, would the Panel be willing to listen to an institutional shareholder whose index weighting requirements prevented it from increasing its investment in the company? How far should the Panel be willing to go to protect a shareholder from the shareholder's own self-imposed restrictions? One area where this issue might again be raised is a share buy-back incorporating a franked dividend, where individual shareholders' tax positions can have an impact on the benefits that they might derive from the buy-back (and hence their decision on whether to participate).

The extent to which the Panel will take into account the positions of individual shareholders remains to be tested.