Cash issue puts heat on Tranz Rail

By Peter V O'Brien

Friday 22nd November 2002

Investment analysts raised an interesting matter about share issues last week. They were reported as saying Tranz Rail's 5:7 offering at 75c for each new share was made at a large discount to the head share price.

They were right if Tranz Rail reinstated dividends but the argument would lose weight if more payments were passed or minimal. A discounted rights issue is valid only if a company maintained the same dividend payment on the new capital or had an effective increase after weighting for the new shares.

The yield goes up in either case, based on the ex-rights adjusted theoretical price for the new capital. A simple but admittedly rare example shows what can happen. Company A has a share price of $1, pays a 10c share dividend which yields (before allowance for imputation credits) 10%. It has a 1:2 share issue at 50c for each new share and says it will maintain a 10c dividend. A shareholder would have three shares after the issue. Assuming no general price increase, the three shares would be priced at 83c each. Maintenance of a 10c dividend would lift the overall yield to 12.04%. The issue would have been made at a sizeable discount.

Shareholders in a company without dividend payments receive no discount gain from a rights issue, apart from the odd phenomenon of some ex-rights share prices tending to revert over time to pre-issue levels.

Taking the share price of $1.25 at last Friday's close, the issue terms produced an ex-rights price of $1.04 and 29c rights' price. No allowances had to be made for a dividend difference, because the company has no attached dividends. It made no provision in the announcement for partial dividend participation of the new scrip.

Tranz Rail's 5:7 issue would raise $66 million, showing the group's figures were based on a rounded 123.32 million shares on issue, giving a rounded 88.09 million new shares.

Assume the company had a 1:2 issue at $1. It would raise $66.66 million and issue 66.66 million new shares. Based on a share price of $1.25, the ex-rights' price would be $1.16 and theoretical rights' value 168.

The total value is exactly the same as the 5:7 issue, with the caveat that new subscribers to a 1:2 issue at $1 would gain an extra 25c a share if they took up rights.

There would be no difference if the rights were sold and an allowance made for a lower dilution factor. The addition of $1.16 to 16c gives $1.32. Adding $1.04 and 29c gives $1.33 after rounding.

Any future gain from Tranz Rail's issue had to be based on a return to profit and dividend reinstatement. The company had several inducements for shareholders and the underwriter, ABN Amro Rothschild, with the underwriter obviously a key to the issue price.

Tranz Rail's announcement said the company forecast a 2003 operating profit, before non-operating revenues and expenses, of $53.1 million and "largely confirmed the company's previous forecast of $55.8 million."

Increased insurance costs and the costs of financial restructuring were the major adjustments from the previous forecast. A bottom line of $53.1 million would be 25.12c a share on higher capital.

There was no indication of the dividend amount, if any.

Assessments of a solid discount issue price must be based on an assumption Tranz Rail would pay a reasonable dividend for the six months ended December and/or the June 2003 year. Brokers, their analysts and other people in the financial community are renewing interest in the group after earlier downgrades. Many customers travellers and freighters have little good to say about the effective rail monopoly.

The company fails to improve a negative image when it tries to deal publicly with accidents (industrial and to the public), criticism about disclosure of the financial state of the Wellington region commuter service and the condition of overall group infrastructure. Tranz Rail's ability to explain everything is admirable (in an cynical sense), but that does not stop those who see a profit in financial dealing from regularly reassessing the company.

The cash issue will raise the necessary $66 million, whether fully subscribed or through underwriters taking up any shortfall. That fact leaves the question whether Tranz Rail will succeed, either in terms of its goals or in the eyes of shareholders and potential investors.

Comments from our readers

No comments yet