“We are pleased to announce a SPP that offers you a chance to buy shares at a 5% discount to the recent market price, without incurring any brokerage.”
That’s a typical comment from the management of an ASX Listed Investment Company or LIC when they are looking to raise capital (click here to learn what a capital raising is and what SPPs are). Although the company may be pleased with more money, as shareholders should we also be pleased?
A nice discount and no brokerage may sound good, but it all depends. Let’s start off with a positive frame of mind and examine a situation where it is a win/win.
A Prudent Share Purchase Plan (SPP)
Some LICs on the market are as little as $50 million in size. Whether the LIC is small or large there are fixed costs within the structure that don’t differ all that much. The amounts needed for various administration expenses, directors’ fees, accountancy fees, etc., won’t change too much regardless of the money in the fund (AUM). In order to reduce the burden of such costs it makes sense for a small LIC to try and grow its investable assets.
Note that I am assuming the extra AUM won’t hurt the chances that the LIC/fund outperforms in the future. If the LIC is trying to pick microcap stocks on the ASX then trying to grow to billions of AUM will obviously make outperforming difficult.
Another benefit is if the LIC sees quite attractive buying opportunities where it can deploy the fresh capital (assuming they have deployed it well in the past!). This could remove the need to sell existing positions where it may be difficult to do so. It can also avoid unnecessary selling that crystallises tax payable.
A very important point for the LIC in considering an SPP is if the shares are trading at a discount or premium to NTA. The latter may enable them to issue new shares above the current NTA. This is accretive to the NTA and may result in upward pressure on the share price.
A More Likely Situation?
We can’t ignore the point though that new capital raised from a SPP also can boost the amounts the fund manager may pay themselves.
The manager will usually receive a fixed percentage of AUMs as a fee, therefore there is an added incentive to grow the funds. I refer here to the model of externally managed LICs which make up the vast majority of the sector.
With the internally managed LICs such as Australian Foundation Investment Company (ASX: AFI) and Argo Investments (ASX: ARG) it is different. Any perceived conflict of interest issues are therefore likely to be less apparent with some of the internally managed LICs.
A sign that the manager might be motivated by the increase in AUM and fees is if they conduct a SPP at a large discount to NTA. The dilution to NTA that occurs from this will not please loyal shareholders or management. The difference though is that management may stand to benefit from fees earned on the additional capital over the decades ahead. Therefore, management in this case have a much greater tolerance for any dilution compared to shareholders.
Questions To Ask
As a shareholder, the discounted SPP offer to recent market prices looks attractive on the surface. Yet to qualify for the SPP you would already have an existing holding. Does the announcement of the SPP put downward pressure on your existing investment? Does a short term discount on a SPP offer make up for any dilution to the NTA of your overall shareholding?
A trap that a LIC investor can fall into is taking up an offer to buy more shares regularly and unintendedly boosting his or her weighting to an underperforming LIC. If the SPP is at a significant discount to market prices I suggest not to rush into applying for shares. It is worth exploring the possibility of at least selling some of your existing holding first, so you don’t fall into this trap.
Justifications For SPPs Or Excuses?
There will always be justifications from management for raising more capital from investors. It is easy for any LIC to cite a reduced fixed costs burden and there being attractive opportunities out there in the market. Another typical argument is the liquidity of the shares will improve and the LIC will get more of a profile within the sector. It is all subjective though and I would keep a sceptical mindset over such claims.
If management are running the portfolio well then it should be quite easy for the LIC to have the funds available to buy new opportunities anyway. The same applies to making the LIC more relevant in the marketplace in terms of coverage. Well managed LICs will get noticed. There are so many disappointing ones to make them stand out!
What Should Shareholders Consider?
The problem lies when the value of the NTA is diluted in trying to achieve outcomes. If the LIC already has hundreds of millions under management, the costs / benefits need to be weighed up carefully. Will extra shares offer significant improvements to shareholders? Is it worth the resultant significant dilution in the NTA if the shares need to be offered at a sizeable discount?
These aspects must be considered on a case by case basis. The important thing is to not be blinded by only thinking about the current SPP offer versus the current share price. There are usually bigger issues at play to weigh up.
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Disclosure: At the time of publishing, Steve Green does not own shares in Australian Foundation Investment Co. Ltd. or Argo Investments Limited.