Biotech Values

[DewDiligence]

Firms Risk Stigma With Offerings That
Tap Their Own Shareholders for Funds

http://online.wsj.com/article/SB120761510085396729.html

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By DENNIS K. BERMAN
April 8, 2008

Where do you turn for cash in times of distress? Family.

Behind the scenes on Wall Street, ailing banks and other capital-starved corporations are planning just such a move: tapping their own shareholders for capital necessary to prop up balance sheets or fund day-to-day business. It's the business equivalent of guilt-tripping your brothers and uncles for money.

These moves are called rights offerings, and they are coming to the markets despite years of stigma, say deal makers in the middle of today's cash squeeze.

"It used to be a question a year about a rights offering," says Richard Truesdell, co-head of capital markets at Davis Polk & Wardwell. "Now it's a question a day."

Another deal maker proclaims that these offerings are "the only way to save the banks."

A rights offering works as a kind of forced capital raise on a company's own shareholders. Typically, a corporation issues a tradable "right" -- similar to an option -- to purchase new shares of the company at a set price. That price is typically set at a discount to market, providing an incentive to shareholders to buy the shares.

If shareholders don't want to get in any deeper, they can sell the right for what may be a small profit. The buyer then pays the company for the shares. Of course, shareholders don't usually like being coerced into doing anything. But in theory, rights offerings allow a company to raise capital without giving away too much to outside investors.

"If capital has to be raised, a rights offering is one of the purest ways to protect all shareholders against dilution, says Lazard Deputy Chairman Gary Parr, a veteran adviser to financial institutions.

By contrast, take the terms agreed to by Merrill Lynch when it cinched a $6.6 billion cash injection from three foreign investors back in January. Merrill agreed to pay a 9% dividend on the preferred stock, a higher price than the roughly 3% common stock dividend.

A rights offering would thus seem a perfectly sensible approach for companies in need of capital, particularly the banks, brokers, and other financial engineers currently in distress. They are virtually standard in Asia and Europe. Swiss bank UBS, for instance, just staged one of the largest rights offerings in history, selling $15 billion of new shares to its holders.

Here in the U.S., however, they carry a completely different connotation: Outright stigma. That is because they are largely viewed as an indicator that a company has exhausted all other financing sources. Since 2003, only about 25 rights offerings a year have been issued domestically, according to government filings. Hedge funds can sometimes distort the value of the rights, buying them up as a cheap way to hedge against short positions. And investment banks aren't so keen on them, because they make less on rights offerings than on standard stock issues.

Still, the perception persists: "Companies are reluctant to do it, because it's viewed as a sign of weakness," says Mr. Truesdell.

Weakness is the last thing that a struggling financial firm hopes to broadcast to the market. For these players -- such as thrift Washington Mutual -- there's real value in getting third-party validation, no matter the consequences.

WaMu is doing just that, selling off a large chunk of itself to a group led by private-equity firm TPG. Investors cheered the potential investment Monday, sending WaMu's stock up nearly 30%. To get the cash, WaMu's current holders will be relinquishing a large amount of control in the bargain.

It might have been better for WaMu's holders to pass the hat amongst themselves. But the results could have been disastrous had the market perceived a WaMu rights offering as a desperate move. That might have set off the kind of run-on-the-bank sentiment that sank Bear Stearns Cos.

Still, in these strange and desperate times, stigma may be the least of some companies' worries. Sometimes you have to go to market with the deal you have, not the deal you want.
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