Issue 241: 2020 07 09: Cheap(ish) Shares

9 July 2020

Shares on the cheap(ish)

Buying stocks that you didn’t know you needed.

By Frank O’Nomics

We’ve all done it. The offer of 70% off a pair of brick-coloured corduroy trousers is just too good to pass up – until you suffer ridicule on wearing them, and remember why you never owned any previously.  Buying something just because it looks cheap is never a good idea, and that goes for investments as well.

Historically, bargain basement equity offers were easy to avoid. When a company wanted to raise cash by issuing new discounted stock, corporate brokers would rally round institutional investors and place the stock. For existing retail investors this was intensely frustrating as, if the funds sought were less than 5% of the firm’s overall value (recently increased to 20%), they did not have to offer new shares to existing shareholders. Institutions were buying cheap shares in stocks that you had stumped up good money for. Not only did you miss buying more below the market price, but you also had to suffer a dilution of your holding (your percentage ownership of the company was reduced). Perhaps those most aggrieved were the issuing firm’s employees, not being given the opportunity to acquire an interest at an advantageous level.

Now, however, all of this has changed with the development of PrimaryBid, which allows retail investors to get involved with new placings of shares in existing companies that want or need to raise cash. Once a potential placing has been announced potential investors receive an email giving them the chance to take part and, depending on the overall level of subscription (and whether you are an existing investor), the shares allotted are transferred onto the platform in which you hold your equity portfolio.

In most respects this is a “good thing”. All investors may be created equally but, hitherto, retail investors were not treated in line with institutions. In the current environment, a lot of good companies need to raise more money, either to shore up their balance sheet to get them through the crisis, or to build up a war chest to take advantage of the opportunities that will inevitably develop. Take for example, Taylor Wimpey plc, a well-known house builder which was looking to build up a greater land bank. Their corporate brokers raised over £500 million by placing shares with institutions and a further £7mn via PrimaryBid, selling shares to employees and retail investors. All new investments were priced at 145p, which represented a 4% discount to the prevailing share price prior to the issue announcement. This looked quite attractive compared to a high earlier this  year of 237p. Another recent issuer, Biffa plc, a large waste removal company was burning cash at a high rate, but felt that, post-crisis it would be better placed than its rivals and wanted to be in a position to take advantage of opportunities; they offered a similar discount to Taylor Wimpey and the offer was similarly well supported.

The more important question is, however, not the price compared to that which existed previously, but the price that the shares settled at after the event. This has been a mixed experience. IWG, the office company, issued shares at 239p 2 months ago, and their investors are now sitting on a very nice profit of around 10%.. The experience for Taylor Wimpey and Biffa provides less compelling evidence for the process. Both are now trading at modest discounts to the issue price and anyone looking to make a quick buck either had to get out very quickly or is now in for the long haul.

Part of the problem may be the very presence of those looking to make a fast profit. The issue price can easily become a barrier that is hard to break through with stale holders waiting to get out.

This brings us back to the original message – it may be best to only buy if you believe in the underlying business and are already a shareholder. Most of us know little about the likes of Biffa,, and with some share prices oscillating by 10-20% over short periods, a 4% discount is neither here nor there. An examination of the motives for the fundraising is perhaps the best place to start when looking to justify being involved. If there are sound business reasons, rather than desperation measures, there is some reassurance. The other factor to check is whether senior management are stumping up some of their own cash. Knowing that the CEO of IWG spent over £90mn of his own money in their placing readily changes one’s perception of the deal.

Perhaps the best recent test of “I didn’t know I needed them” was the placing of new shares by Aston Martin Lagonda. The company raised over £200mn, issuing at a price of 50p – but the company’s IPO only took place in late 2018 – and occurred at a price of  1900p. Those that bought on the first issue are sitting on a 97.5% loss and, while recent buyers are only 2p offside there is a danger that they only got involved because of the low price (or being wooed by the brand). Most of us would quite like an Aston Martin, but that does not mean we should buy their shares.

Overall it is hard to argue that a process that allows employees and retail investors to get involved in new tranches of share issues is a bad thing, and PrimaryBid’s services are long overdue. If markets continue to recover and some quality shares are on offer, I may live to regret writing this article – there may not be enough stock to go round. Either way,  it is important to know why you are buying the shares, how much you are prepared to lose, how much you expect to make, and over what period you are prepared to hold them. Perhaps the best question is: Would you have purchased these shares without the discount? If the answer is no, then it is probably best to avoid them. A bit like those brick-coloured cords.



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