Why do ASX small caps get recapitalised? And do existing shareholders have hope of coming out ahead?

Every now and then, ASX companies get recapitalised for varying reasons. Typically, the company is in a poor state being impacted by factors such as too much debt and too high costs. The case study of Virgin Australia depicts that it can be good for the company, giving it the opportunity for a fresh start. But, as former shareholders can attest to, it isn’t necessarily the best for other stakeholders involved.

What is recapitalisation?

Recapitalisation is a restructuring technique used by companies to raise capital and refinance existing debt. The process involves replacing or supplementing the original equity of a company with additional capital, usually from outside sources. This can be done through issuing new shares, borrowing more money, or both. In some cases, cash may also be raised by selling assets or other investments.

Specific deals may involve the acquisition of further assets – typically discounted ones that the company believes it can add value to.

When companies recapitalise, what does this mean?

The benefits of recapitalisation include increased liquidity, improved debt coverage, and more access to capital. Recapitalisation can also help a company increase its market value and expand operations.

It is important to consider the risks associated with recapitalisation, such as problems plaguing the company continuing or dilution of existing shareholders’ equity. Typically, a company must be in good standing with creditors before attempting a recapitalisation. A company may have to overhaul its board or change its strategy before it will be entertained. There may be new investors onboard too.

If my company is recapitalised, what will happen to my own holding?

It will depend from deal to deal but it typically isn’t favourable. In a worst case scenario, investors’ shares are wiped out – as occurred with Virgin Australia.

In a slightly better case scenario, existing shareholders may be able to retain their holdings. Unfortunatly they will be substantially diluted – yes, even more than ordinary capital raisings. Many would take this as the lesser of two evils, however.

Case studies

Companies can emerge after recapitalisation bigger and stronger. Virgin Australia is the most prominant example in recent times. The pandemic shutdown left it unable to trade and therefore pay its creditors. It entered into administration and was bought out by Bain Capital. While unfortunate investors got wiped out, it was ideal for Bain and the company. It got a fresh start without the debt burden, reinvigorating itself as a domestic only airline.

Another example of successful recapitalisation involves the Australian media company Nine Entertainment Co (ASX:NEC). Faced with an increasingly difficult operating environment due to declining advertising revenue, NEC was able to raise $3.2 billion in equity and debt capital in late 2018. This enabled the company to reduce its debt burden and invest more heavily in its digital offerings which, combined with favourable macroeconomic trends, has helped to improve the company’s financial position significantly.

Yet another successful example is the recapitalisation of the UK retailer, House of Fraser. In 2018, after facing various financial struggles, the company successfully raised £450 million in fresh capital from a consortium led by Sports Direct tycoon Mike Ashley. This allowed House of Fraser to reduce its debt and improve its liquidity position, as well as invest more heavily in its online presence. As a result, the company’s long-term prospects improved and it has continued to prosper since then.

However, they haven’t always worked out well and never guarantee things won’t go haywire in the future. Just look at General Motors that was recapitalised post-GFC and was bankrupt again just 11 years later in 2020.

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