We discuss the merits of the £1.2 billion fundraise and the options for shareholders
Thursday 16 Sep 2021 Author: Tom Sieber

Having rejected a takeover offer reportedly from Wizz Air (WIZZ), budget airline EasyJet (EZJ) is now asking shareholders if they will support it with a cash injection via a £1.2 billion rights issue.

The proceeds from the fundraise, combined with a new $400 million credit facility, will be used to bolster the balance sheet, take advantage of opportunities coming out of the pandemic, and invest in a new generation of aircraft to improve carbon and cost efficiency.

Notwithstanding some possible turbulence in the near term and the risk of a more serious bid emerging before the company can complete its recovery, we think shareholders should take part in the rights issue. EasyJet shares are near their lowest level in the best part of a decade, but the new money would put the company in a much better place and the recovery potential for earnings is significant.

EasyJet has racked up losses amid the fluctuating travel restrictions in place across its key markets in Europe and the UK.

Based on the consensus analyst forecast for 103.05p earnings per share in the September 2023 financial year, at 702.6p the shares trade on an undemanding multiple of 6.8 times. That low rating reflects the risks to the airline industry if Covid continues to cause disruption.

WHY DO COMPANIES UNDERTAKE RIGHTS ISSUES?

Right issues can be an effective way for companies to raise new money for large acquisitions or to strengthen their balance sheet.

This method of raising money is often employed at times of crisis – Lloyds Banking (LLOY) using a rights issue to raise £13.5 billion in the wake of the global financial crisis in 2009, for example.

The Covid-19 pandemic saw International Consolidated Airlines (IAG) and Rolls-Royce (RR.) announce multi-billion-pound rights issues in order to provide financial support as they too had suffered from the aviation sector effectively being grounded for a long time.

Rights issues aren’t always welcomed by shareholders. Their discounted price tends to pull down the market price of a stock, so investors usually face a hit to the value of their investment.

Many companies would argue that’s the price to pay to allow their business to grow – and that the longer-term benefits will more than compensate for the short-term pain.

WHAT HAPPENS NEXT IF YOU’RE INVESTED IN A STOCK HOLDING A RIGHTS ISSUE?

You need to work out why your investee company is asking for more money. Think about the following scenarios:

Does the desired cash only provide a quick fix to a financial problem and not a permanent solution?

If the rights issue isn’t a permanent solution, you must consider whether the company can generate the extra cash needed longer term from operations. Or will it have to take more drastic action such as selling assets, borrowing more money or tapping shareholders for more cash?

If the rights issue is to help fund an acquisition, is the acquirer paying the right or wrong price for the target business? Will the acquisition improve its scale? Will it boost or dilute group profit margins?


FOUR OPTIONS FOR EASYJET INVESTORS AND THE COMPANY’S RIGHTS ISSUE

1. TAKE UP THE RIGHTS

Companies are normally offered the right to buy a set number of shares in proportion to the number they already hold. EasyJet is offering 31 new shares at 410p each for every 47 existing EasyJet shares held in the business as of 8 September.

For example, someone with 470 EasyJet shares would have the chance to buy 310 new shares costing £1,270 in total.

2. SELL ALL OF YOUR RIGHTS

The rights associated with shares in a rights issue can be traded in the market and have an intrinsic value. These are known as nil-paid shares or nil-paid rights.

Shareholders can sell their rights to someone else and receive some money, all without having to sell their existing shares.

It is unlikely that stockbrokers would have the capability to let you trade the rights online, so you will probably have to place an order over the phone.

To calculate the price at which the shares could trade after a rights issue, analysts seek to calculate something called the ‘theoretical ex-rights price’.

An example of how it might work:

Suppose you owned 470 shares in EasyJet ahead of its rights issue. The market price of the shares stood at 791.2p the day before the fundraise was announced.

The value of your holding before the rights issue was announced was £3,718.64 (470 x 791.2p). If you decide to take up your full allocation, you buy 310 new shares at the new price of 410p each. In that case the amount of cash passing to EasyJet would be £1,270.

The total value of your EasyJet shares would be £3,718.64 (your holding pre-rights issue) + £1,270 (the new shares acquired in the rights issue) = £4,988.64. You would own 780 shares in total.

In order to arrive at the theoretical ex-rights price we have to divide the new total value of the investment by the number of shares you’d own.

In this case £4,988.64 divided by 780 gives you 639.6p as the theoretical ex-rights price. In reality, the share price will also be affected by what motivated the rights issue and the company’s particular circumstances at that time.

If you decide not to take up your allocation, you will still hold 470 shares and fundamentally they’d be worth the theoretical ex-rights price of 639.6p each. The total value of your holding would be £3,006.12 which is around 80% of the value of your shares before the rights issue was announced.

It is important to understand there are other factors influencing the price, including bid interest in EasyJet’s case, so they won’t necessarily trade exactly at the theoretical ex-rights price.

At the time or writing, the shares were trading at 590p.

What if you want to sell your rights?

The value should be the difference between the ex-rights price and the subscription price which is 229.6p per share in the case of EasyJet (639.6p-410p). Based on our working example, you could receive £711.76 in cash by selling your rights (229.6p x 310 shares).

That would essentially enable you to recoup the lost value of your investment, as £3,006.12 (value of your shares based on the theoretical ex-rights price) + £711.76 (value of selling your rights) = £3,717.88.

Remember, your investment of 470 shares was worth £3,718.64 just before the rights issue terms were announced.

3. TAIL SWALLOWING 

One route is to sell some of the rights to cover the cost of some of the new shares you buy in the rights issue.

Here, you would sell a sufficient number of the nil-paid rights in order to take up the balance of your entitlement under the rights issue, using the net proceeds of the sale of the nil-paid rights to enable you to do so.

As a consequence of tail swallowing, you would be required to make no further investment to take up the balance of your rights.

4. DO NOT TAKE UP THE RIGHTS

You could allow your rights to lapse. If the EasyJet share price is below the offer price of 410p on the subscription deadline, the nil-paid rights would expire worthless.

But if they are trading above 410p then you may receive a cash payment per nil-paid share approximately equal to the EasyJet share price less the offer price.

EASYJET’S PLANS FOR THE MONEY

EasyJet has outlined various uses for the proceeds from the issue. As well as ensuring it doesn’t face a cash crunch in the event of further disruption, the funds will be used to position the business for a recovery in the aviation industry coming out of the pandemic.

The company already has a strong market position with a significant number of routes across the major European airports. An enhanced balance sheet should help strengthen this position as less robust rivals are forced to restructure and potentially scale back their operations.

Some money will be allocated to investing in the EasyJet Holidays tour operator arm.

Finally, the company is looking to future-proof the business by investing in new fuel-efficient planes as it looks to address increasing concern from investors, regulators and customers about carbon emissions.


SHARES SAYS: In our view EasyJet has a credible plan for recovery and one which is worth backing by participating in the rights issue.

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