Wednesday, 11 December 2013

FKP's rights issue made me a tidy profit

This is just a quick post to update you on one of my investments that I have written about on this blog.  I wrote recently about how I had participated in the FKP equity raising through their rights issue.  I took up my rights and I applied for an over-allocation.

The allowed application for an overallocation was $100,000 however given that the share price was trading at a significant premium to the issue price I figured there would be a massive scale back.  The last time there was a big scale back (in this very stock) I got quite lucky because my broker allocated me much more than I would have received had I held the stocks in my own name.

Below I have outlined how I made my investment decision, what I applied for and what I ended up getting.  I have not yet been able to sell the stock because my work has a minimum holding period for stock trades (which is very common if you work in the finance industry).

A walk through of my investment rationale

First and foremost in an equity raising you need to look at:
  1. Is the company going to go broke?
    • When companies do equity raisings (especially to pay down debt) there is a chance that they are going to go broke anyway 
    • This is the first thing you need to think about before rushing into an equity raising
  2. Does the price represent a good deal for you?
    • If you do not participate in an equity raising you are going to get diluted (especially if the equity raising is non renounceable - i.e. you can't sell your rights) so if the company is not going to go broke you would normally want to take up your rights
    • You need to think about the fundamental value of the company you are investing in and whether it represents a good deal to invest more into this company
The FKP equity raising looked particularly compelling because:
  1. The company was not going to go broke - after raising this capital it would have no debt
  2. The raising price was at a significant discount to the theoretical ex rights price (see my description on that here) and also a significant discount to what I assessed as fundamental valuation.
The big risk in this transaction was that I would apply for a significant over-allocation and get scaled back and so lose the amount I could have been earning on the cash I sent to the company.

What did I actually do?

I had 10,000 shares in FKP (after partially selling down right before the equity raising).  The share price was $2 and the equity raising price was $1.30.  It was a 5 for 9 offer which entitled me to 5,556 shares and I could apply for $100,000 in an over-allocation.

I decided to do the following:
  1. Take up all of my rights (5,556 shares at $1.30 = $7222.80)
  2. Apply for $40,000 in additional shares ($40,000 / $1.30 = 30,769 shares)
  3. The potential loss (if I got completely scaled back) was limited to that $40,000 which would have been in my offset account = $40,000 x 5% x 1/12 = $166.67
  4. The shares continued to trade post the institutional raising at ~$2 (i.e. they didn't go down to TERP) which meant that I just had to get allocated $166.67 / ($2 - $1.30) = 238 (or $310 worth) of additional shares to break even
What ended up happening?

I did end up getting scaled back as I feared however I still made a very healthy profit from the investment because the scale back was not nearly as bad as the break even scenario above (though occasionally it is worse).  What ended up happening was
  1. I got my full rights allocation (5,556 shares) plus an extra ~9,000 shares as part of the over-allocation (remember I just needed 238 shares to break even)
  2. I got a total of ~14,500 new shares which cost me 14,500 x $1.30 = $18,850
  3. The share price continues to be $2 which puts the value of these shares at 14,500 x $2.00 = $29,000
  4. Giving me a potential profit of $29,000 - $18,850 = $10,150
Although the potential profit if I had been allocated all my shares would have been much higher I was still pretty happy with this outcome.  Note that I am not yet allowed to sell these shares and so my profit is subject to whatever happens to the share price until I am allowed to sell them.

Note that not all equity raisings will end this well.  I have participated in raisings before where the share price went well below where I bought in at and I ended up with a significant loss after the raising.  If you ever think about participating in an equity raising make sure you know the potential risks of the investment and speak to your financial advisor.

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  1. I applied for over-allocation and got none back. I would really like to understand how they make these decisions because the ultimate winner here was once again the underwriter.

    Last time there was a rights issue I received my over-allocation. The only difference between this time and last time is I sold out this time to make up the funds for the over-allocation.

    Looks like this strategy backfired!

    1. Ahh that's quite strange! The only reason I got any over-allocation last time was because I was with interactive brokers. Most people I knew didn't get any at all and had a much better outcome this time.

      Maybe they do look at the register as at the time of allocation - it would be good to know how they did it!

  2. Quick question - did you already own shares of FKP before they announced the rights offering or did you buy them after the announcement? If you already owned them, did you by them with the expectation that they would announce a rights offering or did you buy them for some other reason? Thanks!

    1. Hi! I owned the shares before the rights issue (I actually owned them before the 2012 rights issue too). I originally bought them because they were trading at a significant discount to NAV and I thought there may be a chance of an equity raising.

      In this case there was not enough time (allowing for T+3 settlement) to buy FKP between when the shares started trading after the announcement of the rights issue and the record date for the rights issue so I don't think you could have bought them post the announcement.