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Why do ASX companies raise capital at a discount? This is a question many investors ask when they are diluted and one we seek to answer in this article.
Why raise capital at a discount?
The answer lies in the laws of supply and demand. When companies issue new shares of stock, they are essentially increasing the supply of their stock on the market. This increase in supply can lead to a decrease in demand, causing the stock price to drop.
To entice investors to purchase these new shares, companies often offer them at a discounted price during an capital raising. By offering the stock at a lower price, they hope to generate more interest and attract more buyers. Buyers are wooed into thinking they are buying a good company at a bargain price. Our retort would be that if it was a good company, why sell it at its fair price?
If a company issues shares at a discount of, say 5% – you could argue it is no big deal. But companies on life support typically have to raise shares at discounts of up to 50%.
A case study
Take a look at Star Entertainment Group, which we wrote about earlier this week. It did a deal at a 20% discount to its previous closing price but at a 50% discount to its most recent capital raise, done just 7 months ago.
This company faced so many tail winds including:
- AUSTRAC penalties,
- Four shareholder class actions,
- unpaid casino duties,
- fines from state regulators
- Competition from Crown
- Cutbacks in consumer discretionary spending
- The slow return of High Net Worth Chinese tourists and uncertainty as to when (or indeed if) they will ever return in their pre-COVID numbers.
- Its contribution to development at its Queensland properties, and;
- Potential debt repayments
You can see why it had to offer a discount! Yes, the latter of these has been resolved by this deal. The new debt arrangements mean its debts don’t start to mature for another 4 years.
It is anyone’s guess what will happen with the penalties. But even if Star can cut a deal, we highly doubt the regulators or shareholders will be willing to walk away with nothing. In the company’s favour is that the NSW government has backed down on its plans to levy an extra $120m on them and will now just slug them $10m.
At the time, we argued it was a huge detriment to its value. But while this potential killer blow is gone, it doesn’t mean the company is not being hit.
Other reasons why
In addition, offering shares at a discount also helps companies raise a larger amount of capital. For example, if a company wants to raise $10 million, they can either sell 10 million shares at $1 each or 1.25 million shares at 80c each. By offering the stock at a discount, the company is able to sell more shares and raise more money.
Another factor that may contribute to companies raising capital at a discount is the potential risks and uncertainties associated with investing in stocks that need cash. Since these companies have less certainty about the future (and indeed whether there would be a future at all absent the relevant cash injection), this can make investors hesitant to purchase shares at full price.
In conclusion, listed stocks raise capital at a discount primarily to attract investors and raise a larger amount of capital. It is also influenced by supply and demand dynamics and can benefit both the company and its shareholders. However, it is important for investors to carefully evaluate the risks associated with investing in new companies. But unfortunately, few do.
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