the Unicredit issue

Unicredit, a major Italian commercial bank, is in the midst of an equity raising aimed at shoring up its finances to meet new capital adequacy standards being set by the Bank for International Settlements.

It’s doing so in the customary European way, through a rights issue (see my post on rights issues for more detail).  The prospectus is available–but not to people in the US–on the company website.

No E-Z bank is eager to raise new equity today.  Their stocks are trading at well below half of the balance sheet carrying value of their net assets (which is the problem in a nutshell–no one believes the carrying values have much basis in reality).  Nevertheless, many are resigned to doing so.  Therefore, the Unicredit issue is attracting a lot of market attention as it proceeds.

Several aspects of the issue are striking:

its large size

Prior to announcement of the issue, Unicredit was trading at around €6.30 a share.  The issue gives existing shareholders the right to buy 2 new shares at €1.93 each for every one they held at the ex rights date.  The new money coming in from the issue amounts to about 60% of the pre-rights market value of Unicredit.

implied change of control possibility

The shares created by the issue will represent two-thirds of the new total.  The issue has the potential to completely rewrite the share register if traditional large shareholders choose not to participate.  That’s certainly an inducement for them to come up with the money.

the low exercise price

Think of rights as being like short-term warrants.  Suppose the existing shareholder doesn’t want to, or can’t afford to, exercise his right to buy new shares.  What happens then?

Usually, and in this case as well, the issue is underwritten.  That is, the investment bank group arranging the issue agrees to buy, at the rights price, any shares that shareholders don’t.  The underwriters, in turn, sub-underwrite part or all of their obligation to other investors–typically portfolio management companies (this is a whole other, semi-sordid, story–but a topic for another day).  No matter what, Unicredit will get the money it wants.

Underwriters don’t want shareholders en masse to refuse to take up their rights.  It’s embarrassing for all parties, for one thing.  The underwriters, or angry customers who act as sub-underwriters, are stuck with the shares on their books, at a loss and tying up capital.

Their solution?  Coercion.

Underwriters always price the new shares at a discount to the prevailing stock price.  The bigger the discount, the bigger the gun to the head of existing shareholders to avoid having their percentage ownership of the company assets diluted by not taking up their rights.  Conversely, the smaller the discount, the more eager underwriters figure existing shareholders are to give company management fresh capital.

In the Unicredit case, the discount is gigantic.  The new shares will be issued a less than a third of the pre-rights share quote.  More like a cannon than a gun.

the issue appears to be succeeding

…at least in the sense that the current share price is comfortably above the €1.93 level.  The stock hasn’t traded below the rights exercise price since it went ex rights and has strengthened each day, as well.

Unicredit is worth watching closely

This is a bellwether rights issue.  If it goes well–and signs are positive so far–other, stronger banks should be able to raise substantial new equity, too.