The good, the bad, and the ugly of secondary public equity offerings in the UK

When a company is choosing where to raise money, stock markets had been losing ground in the popularity stakes to private equity and debt. However, they have once again shown their value in 2020, as companies rush to shore up their balance sheets in response to the trials brought on by Covid-19. Existing listed companies raised around £17 billion on the London Stock Exchange (LSE) in the first six months of 2020, double the average of the past decade and a record amount for the first half of the year, outside of the 2008–09 financial crisis.

This has helped keep companies afloat, people in jobs, and it has mitigated or avoided the need for companies to borrow their way through the pandemic. This provides a more resilient basis on which to deal with the challenges ahead. It can also act as an accelerator to the plans of those companies in growth-mode.

However, our research into the over 1,600 secondary equity fundraisings which have taken place on the LSE since 1998 demonstrates, from an investor’s standpoint, things are less clear cut. Most companies that raise additional equity go on to underperform their sector. An uncomfortably large proportion wipe shareholders out. But a significant proportion deliver very high returns. The size of a fundraising, or whether it takes place at a discount or premium to the share price, or the size of that discount or premium, tell you little about whether a company will go on to thrive or struggle. Nor do several other factors which might typically be thought to play a role – leverage in particular.

One factor that investors would be wise to pay attention to is refreshingly simple – whether a company is profitable or not. The distribution of outcomes has been more favourable (but still very wide) for profitable companies than loss-makers. This does not mean you should avoid loss-makers entirely as some go on to deliver very good returns. However, investors do need to be especially selective in which ones they back.

In addition, even within profitable companies the range of outcomes is wide, with large proportions both thriving and struggling. The only way to assess which camp a company will fall in is by rolling up your sleeves and carrying out proper fundamental analysis of the company in question, and its management.

Not all fundraisings deserve to be backed. Creative destruction is healthy for economic growth. Due diligence and high levels of discrimination are essential. Passive investors do not have that luxury. They are forced to buy additional shares in response to every new equity issue, if they are to maintain an appropriate allocation to each stock. If there was ever a time when good active management was needed, this is it.

The need to be active does not stop there. Once money has been raised, it is the responsibility of a company’s shareholders to hold management to account on how they execute on their strategy, how they spend that money, and, ultimately, on the sustainability of their business model. To not do so would be complacent at best, negligent at worst. Even passive investors cannot afford to be passive shareholders.

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