Nuplex: The rights issue rip-off

BY TIM HUNTER

This is a story about crisis, fear and greed.

It began last year when Nuplex, an unglamorous Auckland industrial chemicals company, found itself on the receiving end of a huge downturn in customer demand courtesy of the global economic crisis.

It concluded this month in a deal allowing a handful of big financial institutions to extract a ransom from the hamstrung company worth tens of millions of dollars.

How did we get here?

Last November Nuplex foresaw its first-half earnings would plummet up to 25% and warned investors through the stock exchange that full-year profits would "fall short of our previous expectations".

With the world increasingly worried about banks' ability to keep the financial wheels of business turning, Nuplex included an update on its debt position. Loans due to mature this November had been extended to at least November 2010, with one exception. Crucially, as it was to turn out, US giant Citibank was reluctant to roll over its $A50 million debt facility.

At this point, analysts now say, Nuplex should have seen the writing on the wall and looked at raising capital to ensure a comfortable margin of safety during the downturn. The company had a deal with its lenders that its senior debt would not exceed three times earnings on a rolling basis. A fall in performance would put that deal at risk.

In the year to June 2008, Nuplex had earnings before interest, tax, depreciation and amortisation (ebitda) of $121.8m and its secured bank debt was $350m. Its headroom on those numbers was therefore just $15m.

On November 25, Nuplex told the NZX it was expecting an earnings drop of $10-$15m in the six months to December. As it turned out, the drop was more ebitda fell from $60.6m to $43.4m. At the same time, although Nuplex had paid down some of its debt, the loans were denominated in foreign currency and exchange rate moves increased the nominal NZ dollar liability by $23m.

The company had breached its covenant.

Sources say Nuplex investigated raising capital last year and talked to investment bank Goldman Sachs JBWere, but nothing was done. If so, it seems likely the board didn't see the danger.

Speaking to the Sunday Star-Times on Wednesday, Nuplex's Australia-based chairman Rob Aitken said covenants were "a fairly arbitrary number".

"We had our senior debt cover ratio set at three times. Other companies have them at 3.5, four times. It's important to come back to the reason covenants are there. [They] are there as a warning signal so the banks can say `here's a hurdle you haven't met, let's sit down and talk'. It doesn't mean the company's not trading well."

Aitken, on the board since June 2006 but chairman only since November, has reason to be aggrieved about the lashing his company has taken. The business was fundamentally sound. It had been a stolid performer over the years and was likely to remain so once the economic crisis blew over. Banks with a long-term view should have had little fear over the safety of their lending to Nuplex.

Citigroup, however, did not have a long-term view.

By February, Nuplex was deep in talks with its banks about easing the debt covenant and it was becoming apparent some of them were inclined to use the breach as a chance to demand repayment.

The next step was curious. Nuplex's own broker, First NZ Capital, began spreading speculation about the debt covenant breach around the market a move that led to a huge fall in the company's share price. On February 19, the stock exchange issued a "please explain" notice to Nuplex, demanding to know of any reason why the shares should fall 25% in just two days.

Nuplex's answer was to admit First NZ Capital's speculation was true, with the excuse that it expected the banks to ease the covenant anyway so there wasn't an issue.

Market sources say First NZ Capital's move was a classic investment banking tactic to force Nuplex's hand. With its share price tanking and its lenders playing hardball, Nuplex had to do something fast.

The first effort proved to be a shambles. On March 16, First NZ Capital organised a placement and underwritten rights issue to raise $110m, but failed to reach a deal on price with big institutions and "habitual investors" a term likely to include Rich Lister and hard-nosed investor Peter Masfen, owner of about 3.7% of Nuplex.

Pressure mounted with the failure of the deal. Nuplex's revised bank covenants were conditional on raising capital and the institutional investors smelled blood.

Four days later Nuplex announced a seven-for-one pro rata rights issue to raise $132.8m. The discount to the share price was enormous 577 million new shares would be issued at just 23c each. Before the profit warning in November shares were above $5.

The issue would obliterate the shareholding of anyone who didn't take up their rights to buy new shares, but the effect on every shareholder was equal. If everyone took up their rights, no one would lose.

The deal was also underwritten by First NZ which stood to buy any shares unsold, so Nuplex could be certain it would raise the full amount. First NZ's fee for the underwrite was $2.6m.

Analysts have since estimated Nuplex shares will be worth 38-40c after the rights issue, suggesting 23c a share is a bargain buy.

"The stock offers investors compelling medium-term value and recovery potential," was one comment from Macquarie Equities analyst Lyall Taylor.

That wasn't enough for the big end of town. Knowing they had Nuplex by the short and curlies, the institutions insisted on securing extra for themselves through a "call option".

The call option gave a select group of "sub-underwriters" the right to buy a further 99 million shares 15% of the company at just 23c a share. A stock exchange waiver meant the normal requirement for a shareholder vote would be set aside.

With post-rights shares likely to be worth at least 40c (net asset value per share would be twice that), the exclusive side deal effectively delivered tens of millions of dollars straight into the clutches of a handful of investors.

Why?

Aitken told the Star-Times the call option was included at the insistence of "a couple of the institutions".

"If the rights issue went through without the call option that would be sufficient [new capital]. The call option facility was a requirement by the sub-underwriters for us to meet."

While admitting the arrangement was detrimental to other shareholders, he said the company was left with no alternative.

"Well, these are very difficult times and I think that's the case right around the world and instituions are very wary about taking up offers. They're making sure they have a lot of freeboard there."

There are 14 institutional investors involved in the sub-underwrite. Their identities are not officially disclosed, but the biggest is First NZ Capital itself. ACC is another, and others are understood to include Brook Asset Management, Tyndall and Alliance. A further 12 "habitual investors" are in on the deal.

ACC investment manager Nicholas Bagnall said although it was a sub-underwriter it had played no role in negotiating the call option. Asked why the option was required he said, "This question would be better asked of First NZ Capital."

First NZ Capital declined to discuss the matter with the Star-Times.

Asked whether he condoned the "rip-off" of ordinary shareholders, Bagnall said: "Underwriters could be obliged to subscribe to up to $130m of stock if Nuplex's outlook deteriorates. In the context of agreeing to let other people choose whether they are obliged to subscribe for $130m of shares, the fact that underwriters have a call option that enables them to choose whether they get to subscribe to $25m of stock is not the clear `rip-off' that your question suggests."

Bagnall's statement appears to overlook the fact that Nuplex was already paying an underwrite fee of 2% of all money raised.

Other well-placed market sources did not take Bagnall's line. "We think from a retail investor's point of view it's a complete disgrace," said one. "Institutions are over the moon about how much money they've made. Whatever stock they get, they get an absolute bargain. It's a complete gouge and the retail investors have been absolutely disenfranchised."

ACC was the only sub-underwriter to respond to inquiries from the Star-Times.

Aitken, meanwhile, had no doubt who was to blame for his company's woes. "The banks are being, in my view, somewhat paranoid. They are being extremely rigid in their position, saying these things are non-negotiable. I'd have to say our domestic banks were very supportive. Our foreign banks were somewhat more difficult."

Banks may be taking the blame, but others are likely to take the fall. Shareholders are gunning for heads to roll over the debacle and the NZX is conducting an inquiry into the disclosure of Nuplex's debt covenant breach.

In the end, few will emerge from this affair with credit. Thanks to the call option, however, some will be better off than others.

- © Fairfax NZ News