Australian Stock Market Downturns and the Ability of Australian Companies to Raise Equity Capital - Example

Name: Course: Date: Tutor: The Impact of the Recent Global and Australian Stock Market Downturns on the Ability of Australian Companies to Raise Equity Capital Introduction The recent global and Australian stock market downturns emerged as a result of Global Financial Crisis (GFC) that began in early 2007 and ended in late 2009. The turmoil engulfed global markets and economies in a way that had not been witnessed for a long time. Its impact on Australian markets was heightened by the collapse of Lehman Brothers based in United States (ASX 5). Domestic money markets in Australia came under stress, commodity prices fell sharply, the local currency depreciated, offshore funding tightened and most significantly, equity prices dropped sharply. In the primary market, asset prices fell and the prospects of a stable equity market receded. According to ASX (8), this led to a decrease in the level of IPO activity in the market. For ASX listed companies seeking to finance their operations, the inability to find wholesale funding sources implied that companies had to seek to raise capital through the equity market. As such, the secondary capital raisings and particularly for larger companies remained strong during the whole period of the crisis. Thus, this paper seeks to examine deeply the impact of the global and Australian stock market downturns that occurred between 2007 and 2009 on the ability of Australian companies to raise equity capital. The impact of the crisis on the Ability of Australian Companies to Raise Equity Capital According to ASX (6), the severe movements in asset valuations and unprecedented volatility associated with global and Australian stock market downturns led to uncertainties for Australian companies due to the heightened risk aversion of investors to commit more capital in the extreme financial and global circumstances. According to the data collected by the National Australia Bank, the overall business confidence among investors declined at an accelerating rate in 2008 and bottomed in early 2009 (ASX 6). This led to a significant increase in the price of discounts required to get raisings completed. As well, other costs associated with making secondary issues such as the cost of obtaining underwriting support increased. During 2007 and 2008, deposit flows into Australian banks increased significantly above historical levels. According to the ASX ( 9) a conventional safe haven investment and cash management trusts, while showing large inflows during 2007, was subjected to a net outflow in 2008 as redemption freezes in several hedge funds as well as other managed investments developed a contagion effect. There were also notable net withdrawals from managed equity funds between 2007 and 2008 as retail investors aimed to lower their exposure to equity investments. This explains the fact that the largest industry sector in Australia raising capital between 2008 and 2009 was the financial sector. The situation was dominated by raisings by the large four trading banks in Australia during the peak of the crisis and in the early stages of recovery. According to the ASX (7), the listing of new companies dried up completely in 2008 and 2009 while raisings of capital through IPOs declined considerably. The primary issuance market started to gain life again during the last quarter of 2009. New companies were completely unable to come to the market while the listed companies relied more on secondary capital, though it dipped in early 2008 before stabilizing during the rest of the crisis period. The value of the IPOs listed on ASX was $2.5bn in 2008, which was the lowest value of $2.2bn in 2001 when global technology bubble collapsed, leading to a period of recession in the US (ASX 7). New listings started to decline in 2007. In 2009, only 47 companies were listed, the lowest figure since 1995. According to the ASX (7), the average value of new IPOs listed on ASX since 1995 had been worth $9.7bn with around 124 new listings every year. These trends indicated a strong increase in of risk aversion among investors which also negatively affected their drive to participate in new capital raisings. This likely affected the options to be made by companies in capital raisings Wylie (2009) notes that there was significant increase in financial flows into banks such as deposits implying that the retail investors’ appetite for risk assets had declined considerably during 2007 and 2008. This led to market volatility which severely constrained credit conditions during the September quarter of 2008 and the March quarter of 2009 (Wylie). Consequently, the ability of companies to obtain underwriting support for their issues was greatly reduced and thus, their ability to make choices on capital raisings was affected. In fact, as ASX (6) further suggests, “the very tight credit market conditions and very uncertain financial situations facing major global investment banks (including concerns about the solvency of some) during the period September 2008 to March 2009, made obtaining underwriting support very difficult for periods beyond a few days.” Such support was vital during the period given that companies needed to protect themselves against the high risk of a shortfall in capital raising. But as Wylie notes, during that period, underwriters were able and willing to take on underwriting risks for only a short period of time. However, as market volatility reduced, the asset values started to recover, risk appetite among retail investors returned and rights offerings started to rise in an accelerating rate in the late 2009 and companies moved back towards reliance on pro-rata issues. Generally, as Bazzani points out, the Australian equity prices largely mirrored international price levels over the period of crisis. During the financial year 2008/2009, ASX/S&P All Ordinaries Index had lost about 40% of its value by the third quarter of the year before its recovery in the final quarter. See the figure below. Source: Bazzani (originally from Bloomerg) In summary, the increased volatility during the period of the crisis was particularly problematic for companies seeking to raise equity capital since the uncertainty created by the situation negatively affected the willingness of investors to commit new capital. However, as Bazzani points out, the actual experience of capital raisings in Australia over the course of the global and Australian stock market downturns remained strong despite the extreme market turmoil. Responses to initial public offerings reduced considerably in the second half of 2008 and the first half of 2009, before picking up in the second 2009, when some confidence returned to the market. The existing listed companies in Australia relied on secondary capital raisings to repair their balance sheets and to reduce their debt exposures. As well, according to Bazzani companies took advantage of relatively robust profit during the period to increase the extent of reliance on internal funding to support their operations. The following figure demonstrates the steep fall in share prices and number of new equity raisings that was sustained during the first half of 2008. As indicated in the diagram, the value of new equity issues started to recover during the final quarter of the year 2008/2009 as companies took advantages of recovery in prices. Source; Bazzani (originally from Thomson SDC, Bloomerg) The secondary capital raisings remained strong with $98.6bn raised in 2009. This represented a 58% increase above the previous record year 2007 (ASX 14). In fact, more than half of the ASX listed companies raised some additional capital during 2009. On average, over the period of crisis, the most common secondary equity raising methods (by value) were: placements which comprised of 41%; dividend reinvestment plans which comprised of 18%; rights and accelerated issues which constituted 31% and others amounting to 5%. The crisis was most severe during the first quarter of 2009 during which placements comprised of 55% of the total value of secondary raisings and rights issues made up of 20%. The markets started to recover six months to September 2009 when the above proportions reversed with placements amounting to 30% and rights issues 50%. Also, the proportion of the capital raised through SPPs increased from 4% of total secondary to 9% between the first and the last quarter of 2009 (ASX 14). But it should be noted that a company’s size is vital in the determination of the most appropriate type of capital raising as the OECD (10) asserts. Small companies have a limited range of options and thus, they tend to rely more on placements. One of the reasons for this is the different shareholder register structures existing in smaller companies, which comprise a large retail shareholder base. Another cause is limited or no access to internal sources of finance or lending/debt finance. Also, there are various limitations on the ability of small companies to raise significant capital via a rights issue in such periods of crisis. Other reasons include the need for the companies to move quickly as favourable market conditions emerged, and, sometimes, the desire of a particular company to attract a large cornerstone investor (OECD 10). During 2008 and 2009, around 95% of all secondary capital was raised by companies which have a market capitalisation of more than $100m (RBA b). The main capital raising choice for such companies was placements, with DRPs and rights issues also being significant options. On the other hand, smaller companies (with market capitalization Read More