Capital raising is a phrase that suddenly seems very popular amongst S&P/ASX 200 Index (ASX: XJO) companies right now, with headlines like 'Company X goes cap in hand to investors' or 'Company Y set to raise capital for 2020 war chest' becoming seemingly weekly occurrences these days.
In just the last few weeks, we have seen capital raising programs from Flight Centre Travel Group Ltd (ASX: FLT), Bapcor Ltd (ASX: BAP) and Metcash Ltd (ASX: MTS).
Last year, Westpac Banking Corp (ASX: WBC) made headlines with a massive one of its own.
So what exactly is a capital raising and why should ASX investors be wary if one of their companies asks for additional capital?
What is a capital raising?
Put simply, capital raising is a mechanism for an ASX company to raise money. Companies typically have 3 options if they are in need of more capital. The first is to sell assets. The second is to borrow money in the form of issuing bonds (which is the company equivalent of an individual taking out a bank loan). And the third is a capital raise.
Capital raising typically involves offering new shares (representing ownership of the business) to investors in an off-market deal. Normally, a company's shares remain relatively fixed at a certain volume. That way supply and demand for the fixed pool of shares enables the market to set what we call the share price of said company.
But if a company needs extra money, it will offer new shares to investors at a fixed price (usually at a small discount to the shares' recent ASX price). This can be an easy way to raise extra dough for the company if times are tough (like they are right now).
But it's usually the method of last resort for cash-strapped companies that (for whatever reason) can't sell assets or go to the bond markets.
The problem with capital raisings
Issuing new shares seems like a 'no-brainer' if a company needs more cash. But investors often hate them, and here's why.
If Company X has 100 shares outstanding, owning 10 shares gives an investor a 10% ownership of the company and an entitlement to 10% of the company's earnings. But if Company X decides it needs more capital and issues 100 additional shares, that investor's ownership just fell to 5% of the total company with an entitlement to 5% of the earnings without that investor selling anything.
In this way, it can represent wealth destruction for shareholders.
Now if a company is really in trouble, investors might be sympathetic. Better to have your ownership reduced in a company than see it go bankrupt, after all. But don't get fooled by any glossy brochures or sweet talk from a CEO. Capital raisings usually aren't good for shareholders, and (in my opinion) you should be wary if a company you own joins the party.
