Stock markets are for raising money. This should be obvious yet seems often to be overlooked, since for many years they have been much more adept at returning it.
Corporate buyback programmes have been the most consistent prop for share prices. Fund flows data from the US Federal Reserve shows that companies have been the biggest buyers of equities for most of the past 20 years, absorbing sales by households, pension funds, mutual funds and foreigners.
Dividends tell a similar story. In the UK nearly a third of total returns to investors over the past decade have come from dividends, according to Panmure Gordon. Companies last year paid out more than £100bn, a record, with about 65 per cent of their post-tax earnings flowing back to shareholders — much higher than the average 40 per cent ratio at the start of earnings recessions. Citi estimates that more than half of that cash has been coming from companies with trailing payout ratios of at least 70 per cent of their profits.
But a lot can change in three months. Rupert Soames, chief executive of Serco, wrote in the outsourcer’s trading update this week that while his company is making use of government support to combat coronavirus effects “it seems inappropriate to use that cash for anything other than its intended purpose of protecting the financial strength and resilience of our business”. Should his rule be applied universally, then cuts currently implied by FTSE 100 dividend futures — about 40 per cent to 2020 payouts and 30 per cent in 2021 — could prove optimistic.
As yields disappear, attention has shifted from the strong to the weak, and the revival of something called the cash box placing. The wheeze allows UK companies to bypass shareholder pre-emption rights by creating, and then buying, an unlisted offshore shell company. The money for the purchase, which stays in the group, comes from new equity that is sold to select shareholders.
EU law allows companies to increase their share count by up to 20 per cent through these cash-box transactions, though fears of shareholder rebellion explain why few companies have gone that far. However, the coronavirus crisis has accelerated at a pace far exceeding the typical timetable of a rights issue, so emergency fundraising measures have been finding support from the likes of fund manager Schroders and industry body The Pre-emption Group.
Coronavirus business update
How is coronavirus taking its toll on markets, business, and our everyday lives and workplaces? Stay briefed with our coronavirus newsletter.
Yet the relaxing of conventions has yet to help those most in need. So far, cash calls have come from companies such as SSP Group, the travel café operator, and classifieds publisher Auto Trader. These are relatively highly valued stocks that could already measure their worst-case survival prospects in months rather than weeks.
Likewise Hays. The recruitment group, which this week tapped shareholders for £200m ($242m), predicts it will be left with “minimal or no debt” once markets stabilise. The company’s own modelling, involving a four-month lockdown and fees dropping to 2009 levels, did not strain its existing borrowing facilities. The extra cash is mostly just a buffer to reassure customers, the company said, not for working capital.
Reassurance is harder to find among more levered stocks, where shareholders seem more reluctant to step up. Carnival, the cruise line operator, was this week forced to cut the equity portion of its rescue fundraising from $1.25bn to $500m. In doing so, it swapped in another $1bn of debt at an 11.5 per cent interest rate, which sent the shares crashing.
Other companies seeking grace from lenders rather than shareholders include N Brown, the mail-order retailer, whose shares are down more than 90 per cent so far this year, and pub owner Marston’s, which is down about 70 per cent. With their shares already pummelled, it is assumed that even the maximum 20 per cent equity issue would hardly touch the sides.
But would it? Cash-box placings involve brokers inviting select investors to bid for the available shares, and almost always result in a placing at a discount to the prevailing price. But investors are welcome to bid as high as they want. There is no requirement whatsoever for the stock to be sold cheaply.
And nothing in the rules stops banks from underwriting such share sales, including at a premium. Of course, they risk being stuck with unsold stock but, in circumstances where lack of short-term funding has become an existential threat for a lot of companies, guaranteed money has the potential to create a virtuous circle for those that have it.
Asking investors to pay above the market price for shares might sound ludicrous. But consider that many distressed companies have sharply underperformed their peer group in whole or in part because of their cash flow problems. If investors were to help ease this liquidity crunch valuations would rebound, to everyone’s benefit.
Governments and central banks have already pledged to do what it takes. Now it is time for the institutions that have pressured now-struggling companies into hiking payout ratios, and for the investment banks that have been earning big underwriting fees on deeply discounted rights issues, to bear a little more risk and offer a little restitution.
