Investment Matters

A word on - discounted capital raisings

This week Cardno announced a pro-rata, non-renounceable entitlement offer to raise money to reduce its debt.  This coincides with the company being under new management (and part-ownership via Crescent Capital), and it instigating its turnaround.

The new issue of 1 new share for every 2.175 owned was at a deep discount ($1.00) to the last traded price of $3.02.

The theoretical price (TERP) of Cardno shares post this new offer (the blended current price and new issue price) is 17.8% below the last traded price.  However, those who take up the rights enjoy buying shares at 57% below the new “theoretical” share price.

Therefore, for those who have the cash, these types of issues are very enticing (i.e. you want to put more money in given the significant discount and the potential profit on this new investment).  For those who don’t put new money in, such raisings are damaging (i.e. dilutive).  This is because the old price of your shares should drop to the theoretical price, at least in theory.

Discounted raisings can be good, or bad

It depends on the post deal market price, and how much stock you get.

The “net” result of these deals (profit on the new stock, versus loss on what you own) therefore depends on the price the shares trade after the restart, versus the TERP.

In the Cardno case, we think for current shareholders that the “net” will be disappointing as the price may trade lower than the TERP.  This is because the confidence in the turnaround is not strong (after only one month of Crescent control).  We still feel Cardno is better for having Crescent as controlling shareholder.  And the pathway forward for the business is positive, as can be seen from the 'backlog' charts below.  'Backlog' is a measure of future contracts, i.e. future revenue.

Cardno backlog

First Samuel works to improve clients' positions, to benefit from new issues

First Samuel typically has two distinct advantages when it comes to these sorts of issues.

  1. Even though our clients’ accounts are all in their own names and managed individually, we are seen as an institution in the market and by investee companies.  This means we are able to underwrite/sub underwrite deals on behalf of our clients and fight for any stock not taken up by other shareholders in issues.
  2. We have a natural tendency to hold cash and liquidity.  This allows us to be ready for opportunities like this when they come along.  If you don’t have cash, you can’t participate.

Depending on the discount in the offer, it should be clear that the more of Cardno we own at $1ps the better will be our result.  In a best case scenario we may actually be very happy with them raising money in such a fashion, as the capital gain from the new issue will be greater than the dilution of our existing holding.

This is potentially very meaningful and means that we may behave quite differently than you would if the only option, or best option, was simply taking up the rights. We might even encourage some of our companies to raise capital like this, if we will get a good allocation in the issue process.

In the worst case, when we don’t get “extra” stock, clients do receive a fee for underwriting or sub underwriting an issue.  In line with our full and transparent fee disclosure policy we have always rebated these fees back into clients’ accounts. 

We think the Cardno capital raising will be “ok” for First Samuel clients

Because the effect of the Cardno raising is reducing financial risk in the business (which is a good thing, always) we see getting shares at $1 as a very attractive thing to do.  Clients will recall we sold 50% of our position to Crescent at $3.45ps recently.   

Because of our ability to be engaged and involved on our clients behalf, First Samuel clients will receive more than their 'fair share' of stock, which means the concern around a dilutive capital raising is eliminated (if the post deal price is okay, we may even profit from the raising).

Cardno is a substantial business with greater than $1b of revenue, generated from around the world.  Whilst profitability has been below par for the past 18 months (see the chart below), we see the opportunity for this situation to improve quite considerably as Crescent and the new team get stuck in and improve what is already a good business.   Normalised (without ATC, and with the turnaround complete) the company can produce EBITDA of around $100m.

Cardno EBIT

By 2H-2016 (i.e. June half next year) we expect to see signs that the business profitability is lifting off its current sub-par levels towards its normalised capacity.  When the market starts to annualise this performance (i.e. think of it as the reliable level of profit), this will lead to a better appreciation of the value of Cardno.  The issue of shares at $1 will then look very attractive.