13 July 2020
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Will Cochlear address the elephant in the room?

Paul Rickard
23 April 2020

Shareholders in Cochlear, the global leader in implantable hearing solutions, will be asking their Directors a lot of tough questions at the company’s next AGM. This follows a panicked capital raising that has angered both institutional and retail shareholders.

Institutional shareholders are angry that a UK fund manager, Veritas Asset Management, was allocated more than one-third of the placement. It invested $304.5m to buy 2.18m shares at a price of $140 per share, and is currently sitting on a paper profit of over $90m.

Retail shareholders are angry in that they are being fed “the scraps” of the issue and will be heavily diluted. While $880m was allocated to institutional investors, only $50m has been set aside for retail investors through a share purchase plan. More than 33,000 shareholders will be competing for a pool of 357,000 shares – an average of 11 shares each. Assuming 25% of shareholders participate (which is an absolute no brainer because it is $41 in the money), they will get an allocation of about $6,000 each. If 50% participate, they will get an allocation of $3,000 each.

The only winner (apart from Veritas) it seems is JP Morgan who underwrote the institutional placement and will receive a fee of close to $20m.

To be fair to Cochlear, it was the first of the 17 ASX 200 companies that have raised capital in the Coronavirus period of shutdowns. It came to the market on 25 March, saying that it expected a significant impact from Covid-19 for an uncertain period. Together with funding almost $500m in damages awarded against Cochlear following an adverse judgement in a patent infringement case in the USA, debt was expected to push above the Board’s comfort level. The company was taking “pre-emptive and decisive action to ensure it remains strongly capitalised during the current market uncertainties and to position the Company for the future”.

The placement, representing about 10.9% of Cochlear’s existing issued capital, was arranged at a price of $140 per share – a discount of 16.7% to Cochlear’s then share price of $168.00. While not an extraordinarily large discount, on the high side compared to other recent issues. By comparison, fellow health care leader Ramsay Health Care announced a $1.2bn placement yesterday (representing 12.9% of its issued capital) at a discount of just 10.6% to the market price.

And if you look at the market reaction, the discount was too high. Cochlear resumed trading after the placement on 27 March at $163.48 and it has been one way (higher) since then. No wonder institutional investors are peeved.

Of the 17 raisings by major companies, 11 have been conducted using the structure  Cochlear applied (an institutional placement and subsequent share purchase plan for retail investors), while 6 have chosen to use the much fairer accelerated pro-rata non-renounceable entitlement structure (APNEO). Webjet, Flight Centre, G8 Education, Oil Search, Kathmandu and Reece make up this list.

Because the offer under APNEO is made on an entitlement basis in accordance with each shareholder’s current holding (for example, Webjet had a 1:1 entitlement offer meaning that a shareholder could purchase 1 new share for every 1 share held), a shareholder can’t be diluted if they choose to invest.

The offer is made at a fixed price and institutions get to go first (which always occurs whilst the stock is in a trading halt). Those entitlements that are not taken up are typically auctioned to other institutional investors. The stock comes out of the trading halt and then retail investors get their chance to invest. Same fixed offer price, same entitlement ratio, but with a two-to-three week settlement period.

This structure has some disadvantages in that it doesn’t readily lead to bringing in new investors, retail demand can be hard to predict, and it can be a little harder for the underwriter. But that’s why they are getting paid the big bucks.

And although the maximum investment in share purchase plans has been recently increased from $15,000 to $30,000, if the company isn’t making many shares available, applications by retail investors get heavily scaled-back. While It might be a little strong to say “robbed”, some shareholders are materially disadvantaged.

The questions shareholders want the Cochlear Board to answer are:

  • Why weren’t all shareholders treated equally by using an entitlement offer structure such as APNEO?
  • Why was the placement priced at such a big discount to the then market price?
  • Why was a new shareholder “gifted” almost $90m?
  • Why was the amount allocated to the share purchase plan pool of $50m so manifestly inadequate and unfair?

Cochlear’s SPP closes today. It should be massively oversubscribed. Perhaps the Board will hear the message from shareholders and increase the size (which it has the discretion to do so). For equity reasons, let’s hope so.

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