Coronavirus: Why cash calls have created a stink in the City

May 21, 2020

Andrew Bailey, the new Bank of England governor, grabbed the headlines by telling MPs this week the UK may yet face negative interest rates.

He also said many other interesting things during his evidence to the Treasury Select Committee.

Among them was a call on companies needing to raise capital during the current crisis to do so by selling more shares to investors, rather than by borrowing more.

He told MPs: "There will be companies [that] were over-indebted before coronavirus came around and I'm afraid they will have to take responsibility for sorting that out.

"There are companies for which the answer is really going to be to raise equity because, if you were over-leveraged before COVID-19 happened, the answer is not to take on more debt but to go into the equity markets."

On that basis, Mr Bailey could have been forgiven for smiling this morning, when Whitbread, owner of the Premier Inn budget hotel chain and the Beefeater and Brewer's Fayre pub-restaurant chains, announced it was seeking £1bn from shareholders.

Investors, though, were not smiling.

Whitbread has a relatively low level of debt for a company its size - just £323m worth of debt supported by £4.28bn worth of equity - and might ordinarily have been expected to borrow any extra money it needed before passing the hat around shareholders.

Accordingly, Whitbread shares fell by as much as 14% at one stage.

As Greg Johnson, travel and leisure analyst at stockbroker Shore Capital, put it: "We struggle with the magnitude of the equity raise…given the low starting debt position."

Whitbread is the fifth FTSE-100 company to raise money during this crisis after online motor retailer Auto-Trader, exhibitions group Informa, cruise line operator Carnival and catering giant Compass.

Scores of others outside the Footsie have also been raising money.

The vast majority have done so via what are known as non-pre-emptive offers.

Normally, when a company raises money from its shareholders, existing shareholders - as in the case of Whitbread - are invited to buy new shares in a proportion to their existing shareholdings.

For example, if shareholder X owns 10% of ABC plc, they will be invited to apply for 10% of any new shares ABC plc is selling so they do not suffer 'dilution'.

Shareholder X is said to own pre-emption rights.

In a non-pre-emptive offer, new shares are offered to whoever wants them, putting existing shareholders - especially retail investors - at risk of dilution.

Under City rules, before the COVID-19 crisis struck, companies were only allowed to raise an extra 5% of their existing shareholder capital without giving existing investors the right to buy the new shares.

After the crisis broke, the Pre-Emption Group, a body including brokers, fund managers and the accounting watchdog, agreed that - in order to make it easier for companies to raise money urgently - the thresholds would be raised to allow companies to raise an extra 20% of capital without offering existing shareholders pre-emption rights.

It created a stink.

Between the crisis erupting in mid-March and the beginning of this week, more than £3bn was raised by UK companies, with retail shareholders mostly unable to participate - even though many would have wanted to have been able to buy shares at a discount.

Those raising money included household names like retailers Asos, Joules and WH Smith and the estate agent Foxtons.

Brokers such as AJ Bell, Hargreaves Lansdown and Fidelity complained that the arrangement put retail shareholders at a disadvantage and demanded they be included in future.

That is why the other big fund-raising by a FTSE-100 company this week, Compass, was so important.

Compass, which raised £2bn in the biggest share issue by a UK company since the COVID-19 crisis erupted, found a way of including retail investors.

The latter duly signed up for 195 million new shares - only 0.28% of the new shares being issued but, nonetheless, an important contribution.

Compass has set an important precedent for other companies raising money this year (Whitbread is giving its retail shareholders a fair crack of the whip by raising money through a traditional rights issue rather than via a pre-emptive placing).

It is a fair bet that other big name companies raising money on the hurry-up this year will, like Compass, find a way of involving retail investors.

And woe betide the managements of those who do not.

Meanwhile, although Mr Bailey is likely to have approved of how Whitbread sought to strengthen its finances, it is by no means clear others will follow its example.

Ultra-low interest rates will tempt many companies in need of cash to simply borrow more.

Moreover, the tax system in this country still favours debt over equity, as companies can deduct interest payments from their tax liabilities.

A company needing to raise, say, £50m will find it far more advantageous from a tax perspective to borrow that money than to raise it from shareholders.

It is a key reason why so many companies have, during the last decade, deserted the stock market to go private.

Apart from swamping the corporate sector with debt, something that clearly worries Mr Bailey, this also has the malign effect of reducing the Treasury's corporation tax take.

As shadow chancellor, as long ago as March 2009, George Osborne promised to tackle the anomaly.

He promptly forgot about it on becoming chancellor.

If companies are to be made to borrow less, while raising more from shareholders, it may require political intervention for them to do so.

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