By rights in Central Europe

By bne IntelliNews May 11, 2009

Nicholas Watson in Prague -

Desperate times require desperate measures, and that's why on May 1 the conference organiser Informa became the latest in a long line of UK companies to announce a rights issue as a way to cut its debt levels and nurse its balance sheet back to health. Now it looks as though this form of financing could start appearing in Central and Eastern Europe as soon as this year.

"We've had specific queries as to Poland; also a couple of other countries, but those were more fishing for potential deals. Certainly, our investment banking clients see rights issues in Poland as a potential area of new work," says Francis Kucera, the CEE capital markets partner for the law firm Linklaters. "We are now seeing interest in terms of enquiries from investment banking clients as to how and where these sorts of transactions could be done in other jurisdictions in Central and Eastern Europe."

Rights issues have generally, though not exclusively, been a British way of raising money. Rights issues have generally, though not exclusively, been a British way of raising money. The UK makes up 45% of the rights issues launched so far this year, which are worth a total of €56bn. The largest rights issue in Europe in 2009 has been the €13.9bn raised by HSBC.

A rights issue is where a company offers new shares to existing shareholders in proportion to their current stake, respecting their pre-emption rights. The price at which the shares are offered is usually at a discount to the current share price, which gives investors an incentive to buy the new shares. If they don't, the value of their holding is diluted, but the rights are tradeable securities in themselves - a sort of short-dated warrant. This allows shareholders who don't want to purchase new shares to sell the rights to someone who does. Whoever holds a right can exercise the right to buy a new share by a certain date at a set price.

The timing and reason for a rights issue tells the investor a lot. A rights issue to fund the company in question's expansion plans could be regarded as a positive move. However, a rights issue by a highly geared company in order to strengthen its balance sheet, as is happening now, is often a bad sign; profits are already low or negative, and future profits will be diluted.

So why do companies opt for a rights issue and why would it appeal to companies, particularly banks, in emerging Europe?

Secondary issues

Until the global financial crisis swept across the region in the autumn of 2008, companies had been pretty free to do IPOs and secondary share offerings to raise cash, because their businesses were generally headed in the right direction and investor appetite for new risk was generally good. However, the new business environment is much more risk averse, making a rights issue appealing. "The rights go to existing shareholders first and, in an environment where people are risk averse, the view is that people who already know the company and are exposed to it are more likely to invest if the pricing is right, rather than trying to attract new investors," says Kucera.

The general view from analysts is that emerging Europe won't see a pick-up in IPOs and secondary share offerings until 2010 at the earliest, and with the debt markets frozen to all but the highest-grade issuers, this means that companies will be need to look at less conventional financing methods like rights issues to fill the gap in the meantime.

Another advantage of rights issues over more traditional secondary offerings is that they are less complicated and time consuming than a regular share offering that involves new investors - important considerations when funds need to be raised relatively quickly. "It's often easier to issue rights than it is to issue new shares, and so a rights issue can be done on an expedited basis," argues Kucera, who adds that judging from the stage of his discussions with investment banking clients, the first rights issue in CEE should happen later this year.

Polish up

The most likely source for the first rights issue should be a Polish bank. Poland because that's where the region's largest stock market is based; a bank because that's the sector hit first and hardest by the crisis.

The Warsaw Stock Exchange vies with the Vienna exchange as the region's top bourse, aided as it has been by generous legislation that limits the country's Open Pension Funds (OPFs), a pillar of the decade-old reformed pension system, to investing only 5% of their assets outside of Poland. In addition, companies based outside of Poland, such those from Ukraine, have also been attracted to list on the bourse because for the purposes of these OPFs, they are deemed to be Polish companies if they have a listing on the WSE. This size and liquidity makes the WSE sufficiently similar to more developed stock markets like London's, where rights issue are commonplace.

While Polish banks are in much better shape than their western peers, the spare capital they are required to maintain has been similarly eroded by losses from the credit crunch. This makes them ideal candidates for right issues, the feeling being that once one Polish bank successfully completes such an issue, more will follow as investors become more comfortable with the investment vehicle. According to dealReporter, banks that may be looking to raise their tier 1 capital though rights issues include Kredyt Bank, Getin Holding and Bank Millennium.

The big question mark hangs over whether the regulation in Poland and other CEE countries is consistent with rights issues. While the less transparent and less sophisticated stock markets of the former Soviet Union are likely to need legislative changes before a rights issue can take place, Kucera believes the region's EU countries are suitable already. "Talking to lawyers and regulators, there's no particular reason why Central European countries can't do these transactions. If you're looking at CIS countries, where the offering process and the laws are less investor and transaction friendly, I think they are further away," he says.

Others aren't so sure it will be that simple. Frank Jackson, managing director of the UK-listed CEE explorer Aurelian Oil and Gas, points out that the commercial code in Poland is still pretty basic. "For example, you can't have different classes of shares in Poland, you can only have an ordinary share, full stop. You can't split rights up and you can't have some people coming in on a mezzanine level and after a certain event the share will transfer into a different sort of share with different sorts of rights. Whereas in the UK and US you can do that, and then you can start to pick off particular types of investors and have them come in at the PLC level by using a special instrument."

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