Friday, April 29, 2011

Contact Energy Rights Issue: Management Sells Company Short

Rights issues are typically done when a listed company needs more capital to repay debt or needs money to expand their business when more debt is inappropriate. In the case of Contact Energy Ltd [CEN.NZX] their $350 million rights issue, announced yesterday, will go towards expanding geothermal power facilities.

The only question raised by the announcement though is why the rights issue was set at such a massive discount to the current share price. It is usual to discount rights issue placements but not to the extent CEN shares have been discounted. The $5.05 rights issue price is almost 15% less than the trading price of CEN the day before the announcement.

For some reason management have opted to heavily undervalue the issue and one can only speculate as to why. My cynical side is thinking Origin Energy Ltd [ORG.ASX], the current majority owner of the company at around 51%, is looking to creep their share of the company through the rights issue process - they will take up their full entitlement - but my practical side is thinking that the company already has a massive debt burden of nearly $1.3 billion so simply cannot sustain increased borrowing based on their dwindling customer base and subsequent lower profits, so are choosing to dilute shareholding (if rights are not taken up) to finance normal business activities.

Long term investors need to consider their participation in the rights issue in the following manner. If they do not take up the 1:9 rights offer their current shareholding will be diluted but they are likely to be able to sell them on the NZX. However, joint managers Deutsche Bank Craigs and Goldman Sachs will aggregate the rights which are not taken up in June and sell the unwanted shares in a book-build process.

If shares sold through this process go at a premium to the $5.05 being offered to existing investors, those who opt not to take part in the rights issue will get the difference, proportionate to their entitlement.

Those not currently CEN shareholders thinking of buying CEN shares to participate in the rights issue might want to wait until after the extra shares are issued to see if they can buy at a level closer to the $5.50 issue price but some investors will be gambling that demand for the rights to participate will propel the main shares higher and make the whole process a profitable one.

CEN shares initially increased by 15c on the news yesterday but finished down 1c to finish at $5.85.

CEN Rights Issue Documents

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