HKEx rights issue & open offer proposals
7 September 2009
Poll: Rights issues & open offers
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Poll closed: 18:00:00 25-Sep-2009
- Shorten the notice period for book closure for rights issues and open offers from 14 calendar days to five business days with at least two uninterrupted trading days for trading in securities whose holders are entitled to the subscription rights.
- Amend the minimum subscription period for rights issues and open offers from 14 calendar days to 10 business days.
Taking these in reverse, Webb-site.com supports the second proposal, which resolves problems when bank holidays fall in the middle of the offer period, shortening the effective decision time.
As for the first proposal, we support it in relation to rights issues, but not for open offers. In making this proposal, HKEx failed to take account of the fundamental difference between a rights issue and an open offer. Both are offers of new shares proportionate to existing shareholdings, usually at a discount to market price at the time of the announcement, but in a rights issue, the shareholder can choose either to subscribe for his entitlement, or to sell his rights in the market. This allows him to recover the value of the discount at which shares are offered, if he chooses not to invest more cash in the company. In an open offer, the entitlements cannot be separated from the existing shares. The holder must either put up the cash or suffer dilution from the discount at which the shares are issued to other shareholders or to the underwriters. The only way out of this is to sell his shares before the open offer starts, and even then, the anticipated weight of hostages rushing for the exit may crush him on the way out.
Now, the HKEx proposal makes this problem even worse. At present, you normally have at least 7 business days in which to sell your shares before they start trading without the entitlement to the new shares, or "ex-entitlement". Once the shares trade ex-entitlement, the share price will reflect the full impact of the discount in the open offer or rights issue. For a rights issue, this is OK, because ceteris paribus (all other things being equal) the value lost in the share price is matched by the value of your rights, which you can sell in the market. But for an open offer, that's the end of the game. Under HKEx's proposal, you might have only two trading days in which to rush for the exit and sell your shares before they go ex-entitlement for the open offer.
Dilution damage calls for discount limit
Because of the dilution damage caused by deep-discount open offers, UK Listing Rule 9.5.10 limits the discount to 10% to market price. Hong Kong continues to disrespect shareholder rights and the consultation paper makes no proposal to limit the discount on open offers, even though we have been making this point since 1999. Until this changes, HK shareholders will continue to be held hostage to the discount gun of open offers. A few years ago, HK even introduced a 20% discount limit for placings under the general mandate, a feeble step in comparison to the 5% limit in the UK, but still there is no limit whatsoever for open offers.
You might think that you would still have some forewarning of an open offer, because the company would need to call a shareholders' meeting first. Think again. A HK-listed company can launch a rights issue or open offer involving an increase of up to 50% in the number of issued shares (or 1 new share for every 2 shares held) without shareholder approval, provided that it has sufficient authorised but unissued share capital, as most do.
You snooze, you lose
The paper also fails to address another problem with HK rights issues and open offers, namely that companies do not have to account to holders for the value of their entitlements which are not subscribed. So in a HK rights issue, if you snooze, you lose. Someone else will take your rights, and you won't be paid for them. In HK, the unsubscribed rights either go straight to the underwriter (even if a premium could have been obtained in the market) or are allocated by the board to so-called "excess applications".
By comparison, HSBC, which is bound by the UK Listing Rules, paid holders (including HK holders) the value of their unsubscribed rights. The 172.7m shares were placed in the market at 448p/HK$51.83, and the difference from the 254p issue price was paid to the rights holders, worth about GBP335m (HK$3.88bn) less expenses. This is an important protection if you are unaware of the rights issue or open offer or missed a deadline.
Trading ex-entitlements which may not come
There's one more thing. In HK, the stock exchange still allows shares to be traded ex-entitlements even before a shareholder meeting to approve the distribution, whether it is a dividend, rights issue, open offer or demerger. The implication is either that the Exchange thinks shareholder meetings in a controlled-company environment are a trivial formality and nearly-certain to approve things, or the Exchange is reckless in allowing people to sell their shares without knowing whether they will get the entitlement they think is coming to them. The uncertainty of trading ex-entitlements when an entitlement might be voted down creates the risk of disorderly markets. For example, if a company proposes a special dividend conditional on a connected transaction being approved, then independent shareholders might buy the shares ex-dividend and then vote down the deal, benefitting from the company's retention of its cash.
For a buyer ex-entitlements, this is like buying an empty home and then discovering that that the previous owner has left it fully-furnished, against his wishes.
© Webb-site.com, 2009