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Kudos to Rights Issue Underwriters

AFTER nearly 10 months of serenity in the economy some businesses have shifted a gear up from focusing on revival to engaging in expansion.

The economic environment has indeed improved somewhat with the next day promising to be better than today. This time last year the economy was expected to be much worse the following day.

Machine usage in industry rose phenomenally from the December 2008 level of below 10% to 30% by June this year. There is a high probability of ending 2009 at no less than 40%. This will be 20 percentage points lower than the government target of 60%. Nonetheless, it will still be laudable considering that companies are starting from scratch with limited resources.
Over the years plant and equipment in industry became rundown because of lack of repairs, let alone replacement. Machinery at several companies is now obsolete and this is causing serious production inefficiencies. This, in turn, is hampering the competitiveness of local products in the export market whilst encouraging imports.
The capital base of nearly every company was depleted by years of chronic hyperinflation. There has not been any better time over the last decade to closely examine capital than now. The use of stable currencies, low inflation and the opening up of the economy to price mechanism augur well for business planning and growth.
While in March businesses were preoccupied with resuscitating operations, the focus for some is now on strengthening balance sheets in preparation for anticipated increases in business volumes. This might sound overly optimistic to some but the reality on the ground is that many believe that the decade long economic downturn could be bottoming out. Some companies are seriously considering embarking on repairs of machinery, refurbishments of properties and modernising outmoded equipment to improve efficiencies. All this needs money. But the money is just not there; not in sufficient quantities and not at a fair cost.
Considering the dryness of the debt market, companies are forced to turn to equity financing. In previous instalments this column noted that this route has its own problems. Existing shareholders do not want to be diluted and where they give in, differences on valuation arise. Current owners ordinarily want a higher price while potential investors demand steep discounts for high country risk. In the end, if the end is to be sealed, existing shareholders should relent because they are more desperate for funds while the prospective investors can easily take their money elsewhere.
So far four listed companies have announced equity financing structures which include a combination of both private placements and rights issues. Two of them are siblings from the Zimre Holdings stable: NicozDiamond and Fidelity.  The other pair is African Sun and CFX. Fidelity Life raised US$1,7 million from a private placement whose proceeds are earmarked for strengthening the capital base in order to underwrite more business.
NicozDiamond shareholders recently approved a US$4m renounceable rights offer which will dilute shareholding by 28% for those who fail to follow their rights. The proceeds are expected to enable the company to take on more risk. Currently only 50% of the business underwritten is retained while the difference is passed on to reinsurers. This is weighing down the profitability of the business.
African Sun is planning to raise US$35 million from a threesome mix of debt, private placement and a rights issue. The money is targeted at refurbishments of hotels while some will be used to secure leases and management. The company has an immediate need to spruce up hotels in anticipation of business during the 2010 Fifa World Cup. This is commendable although US$35 million could be too much to raise at once for a company that has a market capitalization of US$50 million. One hopes it does not create typical agency problems where management pursue empire-building at the expense of shareholder value creation. 
The fourth company to do a capital raise is CFX. CFX is one of the few banks listed by the central bank as having failed to meet its minimum capital requirement by October 31. The proceeds of the private placement and the rights issue are aimed at capitalising the bank and avoiding the possible alternative of liquidation.   
In all three rights offers, there are high probabilities of the underwriters taking up big portions as most existing shareholders are unlikely to follow their rights. ZABG and CBZ are underwriters in the NicozDiamond transaction while Interfin and ZABG, again, are underwriting the CFX and African Sun deals in that order.
Liquidity in the local market remains thin and this could prevent local investors from following their rights. This could be worsened by the fact that all three transactions have issue prices above or equivalent to market prices. Significant price discounts could have enticed some investors to consider getting additional scrip. As things stand, those unable to take up additional shares could either sell their rights when they start trading or alternatively sell the shares now to avoid dilution.
All that notwithstanding kudos to underwriters for agreeing to take up excess scrip even at huge premiums to market prices.

Ranga Makwata

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