10th February 2023
Back in 2020 we undertook a little project to speak to all our investment trust brokers and as many investment trust directors as possible, to instil more rigour in their capital allocation policies. We first focussed on those trusts whose discounts hadn’t snapped back after the dramatic Covid-linked widening and prodding to check why available liquidity wasn’t being used for accretive buybacks. While we were at it, we reminded brokers and boards of our general corporate governance code that includes, among many other things, the necessity to only raise new equity at a premium to a live net asset value. This requirement is mainly aimed at those trusts that invest in illiquid assets that only publish a NAV infrequently, i.e. the property and infrastructure sector, and those trusts that need to issue new shares to finance future growth, i.e. the property and infrastructure sector. It is therefore not a surprise that according to Winterflood Securities (in their recent Annual Review), that despite a dramatic drop off in secondary issuance (lowest since 2012) and IPOs (the first year there wasn’t a single IPO since 1978), that almost two thirds of the £5.5bn issuance was from the property and infrastructure sector. During conversations with those trusts issuing shares last year, we questioned managers, boards and brokers as to whether the issue price represented a sufficient premium to a stale or live NAV to prevent any dilution to existing shareholders, and on more than one occasion we were regarded as the weird lot in Exeter making a fuss about nothing. If there isn’t a sufficient premium, then all the growth potential from the existing portfolio that long-standing shareholders have funded gets given to the new shareholders too cheaply. Often it was the lack of concern for the potential dilution that made us walk away from participating regardless of the quality of the management and the assets.
After the dry 2022, there are two infrastructure issues happening within a couple of weeks of each other; 3i Infrastructure is looking to raise additional equity, while AT85 Infrastructure is seeking to end that IPO drought. For this note I’m going to focus on 3i Infrastructure as it is a good example of why we, and everyone else invested (physically and emotionally) in the investment trust sector, need to keep banging the corporate governance drum. Very simply, 3i Infrastructure owns private infrastructure businesses across areas such as renewable energy and critical parts of the digital network such as sub-sea cables, fibre and telecoms. Soon after turning on the computer screens on Monday morning, we saw that the company is seeking to raise an unspecified amount of money by way of new share issuance at a price representing a 3.1% premium to the last reported NAV as of 30th September 2022, with an unusually short four-day application window, the deadline being this Thursday (9th February). The fact that the issue price was based of such a stale NAV instead of an estimated live NAV, seemed strange given quite a lot has happened in markets since 30th September!
Given that backdrop, I was intrigued to know more about what must be an amazing and immediate investment opportunity for this to be rushed through this week and on a stale NAV so I tuned into the group call on Monday afternoon. The two main reasons for the equity raise were to create more headroom in the RCF and to allow follow-on growth opportunities in the existing businesses. There is already £350m spare capacity in the Revolving Credit Facility (RCF), which seems plenty and, other than saying any investment is expected to be in excess of the 8-10% return target, I didn’t hear anything specific about what they are going to spend the money raised on. And there was nothing about why right now, nothing about why the rush and nothing about why using such a stale NAV. In fact, on the latter point, the managers made a point about how well the businesses are trading since 30th September, giving rise to concerns that the live NAV might be higher. Indeed one investment trust analyst we regard very highly has estimated that the live NAV is slightly higher than the issue price meaning this issue is taking place at a live discount and therefore dilutive to existing shareholders. It is a non-pre-emptive issue too, which means existing shareholders cannot grab all of that dilution for themselves and prevent “Johnny come lately’s” jumping on board.
Today (10th February) we see that it raised £100m of new equity, which I’m sure everyone involved will regard as a huge success but proves other investors are less concerned with potential dilutive issuance as we are, with liquidity events perhaps a bigger motivating factor. I hope it doesn’t impede on AT85’s ability to raise sufficient capital at its IPO later this month and that the motivation wasn’t simply to get ahead of AT85’s IPO.
We want boards to be more concerned about getting the issue price right as their main purpose is to act in the best interests of shareholders, and we want the corporate brokers to be advising boards on whether the terms are fair for existing shareholders. We accept there are more opinions than just ours that all parties have to listen to, but we won’t deviate from our message to everyone involved that any new issuance of shares needs to be at an appropriate premium to a proven and timely NAV. Otherwise we, and others who share our view, simply won’t invest in investment trusts during the ramp-up growth phase, if we then get diluted once the trust gets to a certain size that allows the bigger investors to come in at any price. Ultimately we would also like to see shareholders be more discerning and refuse to back potential dilutive issues. Actions will speak louder than words.
Daniel Lockyer – Senior Fund Manager
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