‘Nobody ever forecasts for zero revenue’

There are many reasons for this activity. In the case of City Lodge, for example, it is being done to bail out its BEE deal. Curro, on the other hand, is suggesting potential acquisitions, but the education provider also has debt– as does Sun International and TFG. Mr Price doesn’t really need cash but is considering a R3.6bn rights issue to bolster its balance sheet, and Sasol has cautioned about a possible $2bn issue if required – but there hasn’t been further word on this likelihood.

This raises a few questions for investors as well as some important points to consider.

Companies raising money, especially when the need is not glaringly apparent, are doing so because they’re expecting tough trading conditions ahead and are getting ahead of the game. This matters because, at some point, investors will run out of money to fund these capital raises. So, making the play early gets these companies the money now, and might also hinder a competitor that tries to raise cash at a later stage, only to find that investor appetite for this is lacking.

That is why taking on debt is always preferred to a rights issue, because debt is temporary and will eventually be paid back. However, lenders are certainly clamping down on issuing new debt, which means that fresh cash is being raised in the market rather than through debt.

But the big question is: What should shareholders do? Ideally, you need to follow your rights, otherwise you will get diluted. For example, the value of City Lodge's capital raise is more than the company's current market cap, so an investor's holding will effectively be reduced by half if they don't follow their rights. But not all investors have the cash or the enthusiasm to follow their rights, and a decision needs to be made sooner rather than later.

If you can afford to follow your rights – and you’re happy that the cash willbe utilised well and will improve the company’s situation – then do so. But if you’re worried that this might become a bottomless hole, with more capital raises likely to come, you really needto think about whether or not you still want to hold the company.

In the early days of the pandemic,I wrote about needing to take a hard look at your holdings in companies that had high levels of debt and would struggle in this environment – perhaps even needing to consider exiting them. City Lodge was one I did exit.

Sure, the group owns most of its properties, but its recent expansion leaves it with a pile of debt. And, even with the new lockdown regulations allowing for some hotel usage, occupancy levels, and hence income, have collapsed.

As such, I suspect the initial R1.2bn rights issue is not enough, so current shareholders have to consider whether they are prepared to make a number of payments to keep the company going.

Even if the company is a great business, this pandemic changes things like never before. Keith McLachlan of Alpha Asset Management made a comment that has stuck with me: “Nobody ever forecasts for zero revenue.” Yet this is exactly where many businesses have been for the last three months.

Even if you think you missed the opportunity to sell a stock, I’d still give serious thought to those under pressure, especially if they’re likely to be undertaking a number of capital raises. Not all companies will survive and selling low is still better than holding a bankrupt stock.

Read more

This article originally appeared in the 16 July edition of finweek. To read the full story, you can buy and download the magazine here.