Friday, 29 August 2014

I lost money on the last Share Purchase I try again?

"Fool me once...shame on you;  Fool me twice...shame on me".   That old proverb is ringing in my mind as I try and decide how much money I want to commit to the QBE share placement plan (SPP) that was announced in mid August 2014.

This is not the first time that I have had to decide to participate in an SPP run by QBE Insurance.  The last time was in 2012 and I saw an opportunity to make a nice little profit.  However, as I documented on this blog I got scaled back to such an extent that I actually made an effective loss if you account for the amount of time that they held my money before returning it.  I had applied for $15,000 in stock but received a paltry $32.10 and had the rest of my cash refunded to me.

A quick refresh on how to make money from Share Purchase Plans (SPPs)

I thought I would quickly run through how you can make money from share purchase plans.  In fact it is quite similar to making money from a rights issue:  You don't make the money from taking up your rights - the share price should adjust for this.  You make your money from the difference between the price at which you buy the shares and the theoretical price the shares should trade after the raising.

For example.  Assume Company A is trading at $10 per share and there are 100 shares.  
  • The issued capital of the company is worth $1,000
  • Assume that it wants to raise another $500 for acquisitions so it taps it's shareholders for some more money
  • The shareholders aren't necessarily going to give the company all of the money that it needs so the company issues shares at a 50% discount to the current value (i.e. for $5) per share.  It needs $500 so it is going to issue another 100 shares
  • The company now has an extra $500 of cash and an extra 100 shares.  Therefore the company is worth the original $1000 + $500 = $1,500 and there are now 200 shares on issue making each share worth $7.50
  • This $7.50 is the theoretical price the shares should trade at after the raising is done
So how do you make money
in this scenario?  Well assume for a second that you own 10 shares before the equity raising and you bought them at $10 per share.  
  • In order for you not to lose money you need to buy 10% of the new shares that are issued (i.e. $50 worth - 10 new shares @ $5 each)
    • If you only buy your proportionate share you will then have 20 shares worth $150 invested in the company.  Your average buy in price is therefore the same as the TERP: $7.50.  You haven't made a profit or a loss
  • If you decide not to buy any shares then you will still have your original 10 shares.  
    • As mentioned above your buy in price is still $10
    • These however are now worth only $7.50 a share so you have made a loss
  • However you make money buy buying shares that others decided not to buy.  There are a variety of reasons that people may not participate in an equity raising and you can decide to buy their shares at the equity raising
    • If there are 10 extra shares you can buy them all for an extra $50
    • You now have 30 shares worth $200.  Your average purchase price is $6.66 therefore you have made a profit given they are trading at $7.50

So how can this go wrong?

To understand how it can go wrong you need to understand the process by which you apply for the extra shares.  So here is how it can go wrong (and this is exactly what happened the last time):
  • The company doesn't know in advance who is going to buy the shares and who isn't
  • The company therefore allows you to apply for an over allocation in advance of the allocation of shares - in an SPP this is often capped (the QBE SPP is capped at $15,000)
  • You have to submit your bid for shares (and your overallocation) along with the cash for the shares you want to buy
  • The risk is that everyone applies for their own allocation of shares and that there isn't any extra to go around
  • The company then returns all your extra cash (15 days to a month later) and you lose the interest you could have been earning on this cash

Which brings me to my dilemma...

I started this post with a dilemma.  Do I participate in this equity raising or don't I?  I certainly don't want to lose money like I did last time, however it is a very effective way to get an increased exposure to a company that looks good value to me at the moment.

The question I need to assess is the following: how likely am I to be scaled back and what is the opportunity cost of me participating in the equity raising and having my cash tied up for a month.

The first question is quite hard to answer but there are indications:

  • The larger the discount the more people will want to participate and apply for an over allocation.  This is because there is more profit to be made.  In the last QBE raising where I was scaled back significantly the discount was ~18%.  This time it is more like 4% so the likelihood of scale back is less
  • The size of the raising.  Larger raisings require more cash from investors and so you are less likely to get scaled back.  This raising is almost exactly the same size as the last raising ($160m) so there is a likelihood that I will be scaled back
I don't think there is a clear answer either way with this question which brings me to the second question - what is the potential loss if the scale back is 100%.

  • I would be losing $15,000 for approximately a month
  • I have this amount sitting in my home loan offset account earning ~5%
  • The potential loss is therefore 15000*0.05/12 =  $62.50
Honestly the potential immediate profit is so low due to the size of the discount that I would ordinarily probably not bother however I have been looking to increase my exposure to this stock for a little while and this offers quite an effective way to do it without incurring any transaction costs. 

I am going to participate in the transaction...and it will definitely be the 'shame on me' if I get scaled back significantly again.

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