When share dilution becomes the only solution

The greatest ever volume of equity raised by Australian companies in a financial year has revived businesses burdened by heavy debts, and settled investor anxiety about the survival of portfolio companies. But the dilution of profits across expanded shareholder bases is now entrenched, hurting returns unless companies ramp up earnings. SIMON MUMME reports. In late 2008, Paul Taylor and his Australian equities team at Fidelity Investments judged that roughly 50 per cent of the domestic market would conduct big capital raisings the following year. Six months on, after listed companies raised a record $90 billion for the 2008-09 financial year, the team was surprised by how far their estimate fell short. Like other domestic funds managers, Fidelity kept capital on the sidelines as the financial crisis hit markets, expecting companies would soon conduct equity issuances at steeply discounted prices.

In a world with closed credit markets and stressed balance sheets, big capital raisings, some of which reached the regulated limit of 15 per cent of company stock, were the most viable way to restore weak company finances. Even at the expense of share dilution. Corporate survival – not preservation of earnings per share (EPS) – was critical, says Martin Littler, head of core Australian equities with Colonial First State Global Asset Management (CFS GAM). “If you didn’t raise capital, and the business went under, it would be a disaster,” he says. Littler, a veteran Australian equities fund manager, says the boards of big companies debated whether to raise capital and dilute earnings, or ride out the crisis, confident their debts were under control. Highly geared companies with looming refinancing deadlines, such as real estate investment trusts (REITs) and some financial businesses, had no choice.

“They were so close to death. All they’ve done is stave off bankruptcy while they wait for the world to get back on its feet,” Littler says. Companies such as Boart Longyear, Elders and Pacific Brands ran very dilutive raisings, Littler says, while REITs raised equity off already low net tangible asset values, ranking them among the most diluted stocks. In these cases, new capital was used to plug holes in balance sheets rather than committed to earnings-accretive investments or acquisitions, ensuring EPS dilution for the foreseeable future. But for some investors, the big discounts on offer easily compensated for the dilution. “Beauty is always in the eye of the beholder,” Littler observes. Because the raisings were primarily conducted by the larger companies in the index, the discounts provided good opportunities to buy into them, Fidelity’s Taylor says, pointing to the big four banks.