Saturday, 11 February 2012

Last roll of the dice

The capital raising proposal soon to be presented to shareholders represents Plan X for Gunns Limited.

If the previous plans including closures, layoffs, looting IGA funds and asset sales had worked there would have been no need for Plan X.

But they didn’t.

The banks’ patience is wearing thin I suspect. Raise more equity, and soon, would have been the message. Debt reduction has been disappointingly slow so it would have been too much to expect existing shareholders to subscribe for a pro rata rights issue without a new Plan such as getting Richard Chandler (RCC) to put in $150 million. Good move by Greg, it keeps the banks on side for a while and provides a basis for asking existing shareholders for more.

But it will put shareholders in an awkward situation. Greg is essentially saying to them, if you want to hang in, put in more and suffer a dilution of the asset backing of your shares or don’t do anything and suffer a massive dilution.

The shareholders are between a rock and a hard place. Currently their Board tells them their shares have asset backing of 91 cents each, but the market says they’re worth only 12 cents each.

Suppose shareholders let RCC thru’ the door with its $150 million then the asset backing of their shares will fall to 44 cents if shares are allotted to RCC at 12 cents… a fall of 47 cents per share, a 52% loss. That’s a massive dilution, a massive transfer of paper wealth to RCC, some of it accumulated from us taxpayers who helped subsidise MIS schemes which assisted Gunns in acquiring its major asset, its land and trees.

Another subsidy to carpetbaggers.

Another triumphant public policy outcome.

So Greg has given the existing shareholders a chance to suffer less of a dilution, but only if they put in another 15.6 cents per share. Greg will give them another 1.3 shares for each existing share, so for each existing share they will end up with 2.3 shares with asset backing of 76 cents. It will cost them 15 cents to give away 15 cents, in other words a loss of 30 cents per share.

Better than 47 cents per share I guess.

Some choice. But what’s left will be a little safer.

It’s a little like playing poker, there are times when one may be persuaded to add a few chips to the pot just to stay in the game, because you won’t get a look otherwise.

RCC will put in $150 million but up to $75 million might be in the form of a convertible bond, which really gives him the best of both worlds. Forgoing shares means he’ll be forgoing dividends, but there won’t be any, so no loss there. Instead he’ll get paid interest and he’ll be able to withdraw his funds ahead of other shareholders, in fact ahead of creditors. It’s a win-win situation. If things go well he’ll convert to shares and get the upside; if not he’ll get interest on the way and be able to withdraw his funds ahead of most other stakeholders.

The interest rate on the convertible bond should be attractive. Currently Gunns’ hybrid securities known as FORESTS ($120 million in total) are paid interest of 10% on the face value of the security. And the FORESTS will rank ahead of the bond meaning they are less risky. So the interest on the convertible bond may be more?

Rights issues don’t always work. A bit over 2 years ago Gunns raised $335 million from institutional shareholders, via a rights issue but only about $1 million of a possible $90 million from retail shareholders. In that instance the market price had fallen below the rights offer price so shareholders saw little reason to take up the offer.

Towards the end FEA tried a rights issue, a little different to Gunns’ in that it was underwritten in the case of a shortfall. Not all shareholders contributed, notably absent was Gunns itself, then a major shareholder on FEA’s books. A better response may have helped FEA survive although it was the banks refusal to allow FEA to use the rights proceeds as working capital which brought about its demise at that time. This is not to say that it would’ve lasted much longer anyway.

If the rights issue is a complete failure, then RCC may not proceed with its placement. If it does it will end up with 60% of the company. If it doesn’t Gunns will be pretty close to the edge.

RCC is holding most of the trumps at this stage. RCC is taking a risk, but RCC has got an exit path. It’s certainly not a question of the mill or bust for RCC.

The capital raising if successful should ensure that holders of FOREST hybrids will now breathe a little easier, with indications that at some stage they will be redeemed at face value (of $100).

But the market price of FORESTS only rose to $60 following the capital raising announcement which my bookie tells me implies an even money chance of Gunns still falling over. So punters are still are little wary.

It’s easy to see why private placement above a certain % of issued capital requires shareholder approval. Otherwise it would be so easy to arrange a large transfer of shareholder value to a supposed White Knight.

Gunns’ watchers may recall that Gunns raised $25 million in a private placement of shares early in 2011 when it needed to complete the purchase of the Bell Bay sawmill from FEA in a hurry after financiers pulled the pin at the last moment. As it was below the threshold limit for placements, shareholder approval wasn’t required.

It’s certainly been a better week for Gunns but it’s only a small step, it’s not a giant leap forward as some reports suggest. It’s too soon to draw too many conclusions. The dilutionary effects of the proposed capital raising highlight the desperate plight of Gunns.

The half yearly result expected this month should reveal more.

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