Tuesday, 3 April 2012

Making money from Share Purchase Plans (SPPs)

A common way for companies to raise money in Australia (though I have heard it is not as common overseas) is via a non renounceable entitlement offer (often called a share purchase plan). I will go through an outline of what an SPP is and how you can profit from it as a retail shareholder

What is a share purchase plan?

A share purchase plan (or entitlement offer) is a right given to all existing shareholders in a company to purchase for a defined price extra shares in the company (normally at a significant discount to the current price). This is a cheap way for companies to raise funds from the market as it does often does not involve a full prospectus.

The entitlement offer is normally offered to both retail and institutional shareholders with the institutionals setting the price during the bookbuild period (1 - 2 days after the entitlement is announced) and the retail shareholders being offered this same price with more time to make the decision (up to a month later in a lot of cases)

Should you participate in a SPP?
In a word - yes as long as you have the money and you still believe in the company. This is because if you don't you will have your proportionate shareholding in the company diluted. If you take up your proportionate share at the lower price then you are just as well off.

How to make money from an SPP
However the real way to make money from SPP's is by buying in excess of your proportionate shareholding. I will use an example that recently applied to me. The company was QBE Insurance an ASX listed company:

  • Original number of shares held: 32,

  • Original purchase price: $33.00

  • Original purchase value: $1,050

  • Share price pre raising: $12.00

  • Value of shares held (pre raising): $400

  • Existing profit / loss: $(650)
As is pretty evident above this is one of my less successful investments and it was bought while I was university prior to the GFC. I kept it as a reminder to always do my research and also to remember that markets fluctuate a lot so even if you think you're making a good decision some returns will be out of your hands.

As luck would have it QBE recently decided to do an equity raising where a shareholder could subscribe for $1000, $2000, $5000, $10000 or $15000 worth of shares at a price of $10.70 subject to a scale back if there was an oversubscription.

As I outlined above the way to make money from these investments is to buy a greater than proportionate share of the investment as it will usually trade between the original price and the issue price. For QBE it was even better because post the institutional raising it was trading above the original $12 (it was trading around $13) which gave the investor certainty around profits.

So if I continue my example from above

  • New shares bought ($15,000 @ $10.70) = 1,401

  • Total shares now owned = 1,401 + 32 = 1,433

  • Total amount invested = $15,000 + $1,050 = $16,050

  • Average purchase price = $11.20

  • Current share price = $13.00

  • Total book profit = $2,579.40

Thus by getting my full allocation of shares and selling at market price I would change a $650 loss into a $2,600 profit. Note that any scale back of the investment would reduce this profit but even one share allocated to me would reduce the loss that I currently had.

The one big thing to note is that if you don't participate then you are providing the profits for others who do participate.

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