Investors in the Australian share market at some point or another have been offered a Share Purchase Plan. Companies offer Share Purchase Plans to raise capital to fund a new acquisition. The definition of a Share Purchase Plan is an offer to existing shareholders to purchase further shares. This is usually at a discounted price. Shareholders can purchase up to A$15,000 in new shares. These Share Purchase Plans are usually a way for companies to raise capital for a new project without having to take up debt. There are two types of Share Purchase Plans – a renounceable and non-renounceable.
Non-renounceable means eligible shareholders cannot transfer their rights to new shares under the offer. This means they cannot go and sell their entitled shares to a third party ie selling it on the stock market. A renounceable offer is one where the investor is able to transfer their rights. Those who do usually sell those rights on market to realise the value that is inherent in the offer (usually because the offer is less than the current share price).
These are the advantages and disadvantages of Share Purchase Plans:
Advantages
No Brokerage: Share Purchase Plans are offers directly from the company so no third-party intermediary is involved.
Discount: Share Purchase Plans are usually offered at a discount of the market price of the share to entice investors to participate.
No Prospectus: This method of capital raising is cheaper for companies as they do not need to issue a prospectus.
Limited to $15,000: Shareholders are protected from losing more than $15,000 as this is the capped investment. It also enables all investors to have access to the same benefits, whether you are a major shareholder or not.
Less Debt: Companies may decide to initiate a Share Purchase Plan as they may not want to take on more debt. Further debt may increase interest payments and this may reduce net earnings.
Disadvantages
Unfair Distributions: All investors are offered up to $15,000 of shares to take up so whether you have a holding of 20,000 shares or 10 shares, you are still offered the same amount. This is not a fair distribution of shares within shareholders. So it can be an advantage if you are small shareholder, but a disadvantage if you are a large one.
Scale-backs: If the Share Purchase Plan is very popular then it may be scaled back. This means that shareholders will only receive a fraction of the initial offer of A$15,000 worth of shares.
No Certainty: Shareholders will not know if they will receive the full number of shares that they apply for at the time of application. This is all dependant on the demand in the market. Shareholders may receive less than applied for due to an over subscription. Conversely, the Share Purchase Plan might not eventuate at all if not enough shareholders apply.
Can’t Sell on the Market if Non-Renounceable: If the Share Purchase Plan is non-renounceable then shareholders can’t sell their entitled shares on the market. As investors are not obligated to take part, if they do not take up the offer then it will just lapse.
Share Dilution: If a shareholder does not take up the rights issue they run the risk of their shareholding being diluted as extra shares have been issued to existing shareholders.
The decision to take up a Share Purchase Plan needs to be evaluated on an individual company basis. Most Share Purchase Plans are offered at a discount but investors need to determine whether this new acquisition will increase the earnings capacity for the company. If the company is fundamentally sound and the new project looks like it will add value to the company, then taking up the Share Purchase Plan could be a good idea. In the recent case of Bellamy’s, the stock rallied after the offer was announced as the market had the view the purchase of the canning facility would add value to the company.
Lauren Hua is a private client adviser at Fairmont Equities.
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