A Retail Investor’s Strategy For Discounted Capital Raises

This post is an idea and a diary entry, but not financial advice, and you should click here to read our detailed disclaimer.

Over the last few weeks quite a few investors I know have been talking about the potential to profit from participation in discounted capital raisings. For the fundies, they are to get an allocation in the most attractive raises at large mega-cap companies. This can work out very profitably for them.

To take an extreme example, institutional investors who bought shares in the Webjet (ASX: WEB) capital raising at $1.70, could currently sell those same shares for $2.94, a gain of over 66% in just a few days. 

In comparison, retail investors are only entitled to a 1-for-1 entitlement offer, despite Webjet’s dilution being more than 1-for-1, overall. And they will not be able to sell their shares until 29 April. But on the upside, the chances are that they will be able to sell for more than $1.70, and it’s a risk I’d probably take if I was still a shareholder.

However, this opportunity will be of maximum benefit to people with a smaller holding who bought at lower prices. That’s because retail investors are able to “top-up” their entitlement if there is enough supply (and there really could be). If I just had a small entitlement I’d probably try to get as many shares as I can for $1.70 (or at the very least sell my shares and use that money to apply for shares at $1.70.)

Now, this isn’t much comfort if you seriously down on the investment, but if I buy into a stock not long before the capital raising, and can buy plenty of shares at the capital raising price, then the whole process can be quite profitable. This is especially true in the case of a share purchase plan (as opposed to a rights offer).

For example, a shareholder who owns even a tiny amount of shares in Cochlear (ASX: COH) can currently apply for up to $30,000 worth of shares at a share price of $140, despite the fact the current share price is around $180. That means a fairly small holding in a decent company could be a ticket to a much larger holding at an attractive price, or at least a price that provides a potential for a quick profit. Of course, every SPP is different so there is no guarantee small investors will get an outsized allocation (though a $1,000 or $2,000 minimum is quite common.)

Now, no profits are guaranteed, but having the option to participate in certain discounted capital raises can be valuable. So for that reason, I’m taking tiny positions in a bunch of decent companies that I think might raise capital.

In choosing a company that is worth buying for its potential capital raising, I am mostly looking for survivor companies with a decent-quality business model that is very likely to bounce back as the economy recovers from the pandemic. Ideally, the business is not guaranteed to need to raise, but is likely to suffer a temporary drop in revenue that puts its balance sheet (on which I would expect to see some debt) at risk. 

In this kind of scenario, the very fact that the company has raised capital should de-risk the investment somewhat, and if I have correctly chosen businesses that are going to bounce back, then either the market will reward that lower risk immediately, by looking through to brighter days, or the business itself will eventually prove its value by bouncing back, at which point I will have purchased shares at an attractive price.

While there is no guarantee that any of these capital raises will happen, nor that the prices offered will be sufficiently attractive, I have Bought These 10 Stocks For A Potential Discounted Capital Raise. My strategy isn’t to maximise the chances of a raising, it’s to maximise chances of a raising that I feel comfortable participating in.

For each of them I have considered the probability they will raise capital but my priority has been choosing companies that I think will definitely survive, and so may re-rate after raising capital (which should ensure they get through this difficult period). As a result, I’ve avoided higher risk debt plays like REITs and super-high operating leverage, like retailers. Of course mine may not be the best strategy, and may not even work, but I feel it has favourable risk versus reward. Of course, I will assess each offering that does occur on its own merits, and make a decision about whether to participate at the time.

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