Curro: rights issue, wrong time

One of the fundamental reasons to list a company on a stock exchange is to access capital from the market. There’s so much strategy in capital raising that an entire industry of highly-paid advisors and bankers exists around it.

Curro Holdings, one of the private school companies listed on the JSE, has announced a rights issue. The Foschini Group did the same thing this week, but they weren’t allowed to sell any clothing in South Africa for many weeks under lockdown, so that kinda makes sense.

Curro, on the other hand, kept charging school fees. Why do they need to raise money? More importantly, why do they need to raise an amount of R1.5bn when the entire company is only worth R3.5bn?

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Shareholders will be marking this homework

When companies do small capital raises, they can follow an accelerated bookbuild process. That’s an invitation to the general market to indicate interest in taking a number of shares at a particular price. When the book closes, the shares are allocated and the capital has been raised. The bankers head off for a boozy lunch in Sandton and toast their success.

Large capital raises, on the other end, require shareholder approval. This is to protect shareholders from abuse, either by the company or by the anchor shareholder. Curro is issuing 45 shares for every 100 already shares in issue, which is well above the 30% threshold that triggers the need for a shareholder approval by special resolution i.e. 75% of shareholders voting in favour.

JP Morgan has been vocal in the local market about the time required to raise capital during a time of crisis. They believe the JSE should be willing to fast-track the process. Other big names in the market have even called for companies to be able to raise money without asking shareholders for permission.

I’ll be blunt here: these people are conflicted and are wrong. Obviously, bankers and big hitters want to be able to raise money without jumping through any hoops. It helps them earn more fees, take more risks and generate more wealth using other people’s money. That’s exactly why the JSE regulates the market and protects minority shareholders.

Curro has had a mixed report card

Although the company has become a household name, shareholders have had a horrible time of it since 2015. At one point, Curro traded at the most ridiculous Price/Earnings ratios I’ve ever seen. To justify that valuation, Curro would’ve needed to achieve incredible growth over many years.

They didn’t achieve this growth, as the share price chart clearly shows. Shareholders who have held Curro shares for the past few years will be wishing they had enrolled at a different school.


Why raise capital when the share price is so low?

Capital raises in desperate times are normally done for desperate reasons. It’s therefore puzzling that Curro has elected to raise so much money when the share price is depressed and the market has been in ICU.

Or is it so puzzling after all?

Curro suggests that the reasons for the capital raise are to:

  • Undertake acquisitions based on current market opportunities (i.e. buy schools that are running out of money); and
  • “Proactively reduce the gearing levels of the company” which is a nice way of saying “pay down debt before things get ugly”

The first reason feels like window dressing to me. The real story here is that Curro has too much debt and needs to get rid of some of it.

There might be another angle to this, too.

Conflict of interest, anyone?

Curro’s share price is low. PSG holds around 55% of Curro, so they control the Board. PSG just unbundled Capitec to shareholders, so they need to remind everyone of their strategic relevance.

But now Curro wants to suddenly pay down debt?

Forgive me for being a cynic, but when PSG controls the Board and is also underwriting the rights issue at a time when the share price is so low, it quickly feels to me like PSG is setting the test, writing it and marking it too.

Understanding underwriting

An underwriter is an investment bank, institutional investor (like a large asset manager or a private equity fund) or family office that agrees to make sure that the company raises the full desired amount. For example, if a capital raise of R1bn is attempted and shareholders only take up R800m of the offer, the underwriter must take up the remaining R200m.

The underwriter usually takes a fee for this, calculated as a % of the total capital raise (i.e. R1bn in the above example). This is a great deal for underwriters who don’t mind ending up with the shares, which is why existing anchor investors in companies often underwrite these issues (like PSG).

A rights issue designed with PSG in mind

The discount for the rights issue is only 10% to the current share price, which is well below discounts I’ve seen in rights issues when times were good, nevermind when things are terrible.

You set the discount on the rights issue based on the risk you (and the underwriter) are willing to take on the full capital not being raised. A small discount doesn’t encourage people to follow their rights, which allows the underwriter to mop up shares.

In this case, PSG could increase its stake in Curro to more like 70% from the existing 55%.

Let’s wait for the circular

Curro needs to issue a circular and get 75% shareholder approval to do this capital raise. The circular will give more details on the intended usage of the funds.

This approval mechanism is designed to protect shareholders from abuse. The power PSG has over Curro and other shareholders is clear to see. Without the need for a shareholder vote, PSG could underwrite huge capital raises whenever the share price drops and other shareholders would simply fade into the shadows.

With respect to JP Morgan and their ilk, that’s why the JSE should be ignoring everything the bankers are saying about capital raises without shareholder approval.

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