Brian Gaynor: Different ambitions in quest for cash

There are important differences between the Rakon and Pyne Gould Corporation capital raisings announced this week.

The Rakon issue is relatively small, $65 million compared with the company's pre-announcement market value of $191 million, and the funds will be used to expand its Chinese manufacturing expansion.

Rakon is raising its money through a $45 million institutional placement and a $20 million Share Purchase Plan.

By contrast the Pyne Gould raising is huge, up to $270 million compared with its pre-announcement market capitalisation of $113 million.

The company is having a massive six for one rights issue at 40 cents, followed by a $15 million to $30 million placement and a Share Purchase Plan estimated at $3 million.

The Pyne Gould issue is more like an IPO than a traditional capital raising because the company is virtually starting from scratch again as it transforms itself from an investment holding group into a banking and fund management organisation.

These features make the Pyne Gould capital raising more difficult to assess than Rakon's.

Rakon listed on the NZX on May 16, 2006 following an IPO at $1.60 a share. The IPO raised $66 million with $56 million going to the founding Robinson family and only $10 million to the company.

The quartz crystal manufacturer was an instant hit with investors and its share price surged to an all time high of $5.80 on May 25, 2007.

This was shortly after the acquisition of the UK and French operations of C-MAC MicroTechnology and the placement of 14.8 million new shares at $4.05 to institutions. A further 5.5 million shares were issued under a Share Purchase Plan at the same price.

Rakon never achieved the earnings before interest tax, depreciation and amortisation (ebitda) of $26.9 million projected at the time of the C-MAC acquisition and its share price plunged to a low of just 62c earlier this year.

The current capital raising of $65 million will be used as follows:

* $30 million for stage 1 of its Chinese manufacturing expansion.

* $15 million for working capital.

* $6.3 million to settle with its Chinese joint-venture partner.

* $7 million to pay down debt.

* $6.7 million for other capital expenditure initiatives.

The company also announced that it is estimating - as opposed to forecasting - March 2010 year ebitda in the range of just $4 million to $8 million compared with projections of $26.9 million at the time of the C-MAC acquisition.

However it is expecting a big recovery in the March 2011 year with ebitda estimated to be between $30 million and $35 million.

On Wednesday the company placed 39.1 million new shares at $1.15 each with institutional investors in New Zealand, Australia, Asia and Europe. This represented a 23 per cent discount on the pre-issue price of $1.49.

Rakon's reputation has been severely damaged over the past few years and confidence won't be restored until its Chinese manufacturing activities are a proven success. The March 2011 year, when the company is estimating a substantial increase in earnings, will be critical in this regard.

Pyne Gould Corporation, a long-established Christchurch company, joined the NZX on March 30, 2004 as a compliance listing (it didn't raise any new capital).

Its main businesses were Marac Finance, which contributed approximately 63 per cent of group earnings, Perpetual Trust, which supplied 6 per cent of earnings and a 55 per cent stake in Pyne Gould Guinness, which contributed 31 per cent.

Marac Finance was formed from Allied Finance and UPC Securities and is a totally different company from the highly regarded Marac Holdings, which was delisted from the NZX in 1986 following a successful takeover offer from NZI Finance.

Pyne Gould's share price hit an all-time high of $5.40 in September 2005 but weakened considerably earlier this year when investors realised that PGG Wrightson and Marac were experiencing major problems.

Pyne Gould's stake in PGG Wrightson has fallen to 20.7 per cent following the merger between Pyne Gould Guinness and Wrightson.

Two months ago, on July 21, Pyne Gould made a detailed announcement to the stock exchange outlining a major change in direction, which it hoped would enable the group to become "New Zealand's only publicly listed banking and asset management company".

The announcement had a particularly strong emphasis on the purchase of Equity Partners Asset Management (Epam), a fund management company owned by George Kerr.

This purchase was greeted with amazement in the investment sector because the $18 million purchase price seemed to be far too high, little information was given on the acquired company and shareholders weren't asked to approve the transaction even though Kerr is a Pyne Gould director and its largest shareholder.

It was also strange that Pyne Gould put a strong emphasis on the growth potential of Epam when it would have to ask Epam's fund management competitors to contribute to the group's capital raising.

The aim of the July 21 announcement would have been to bolster investor confidence but this has not eventuated as Pyne Gould's share price has fallen steadily from the pre-announcement price of $1.78.

On Thursday Pyne Gould announced its $270 million capital raising with the proceeds to be used as follows;

* $35 million of new equity for Marac.

* $35 million will be applied to reduce Pyne Gould's parent company debt.

* $125 million will be used to partially fund the purchase of Marac's property loans. As these loans are being purchased for $85 million more than their market value then $85 million of the $270 million being raised will effectively vanish on day 1.

* $4.5 million will be used to subscribe a new issue by Epam (this has raised only $28 million of the $60 million sought).

* $13 million will be used for fees associated with the capital raising.

The remaining $50 million plus will be invested in the business.

The $13 million fees represent a whopping 4.8 per cent of the $270 million to be raised. No data has been supplied on the fees associated with the latest Rakon issue but when this company raised $60 million from institutions in 2007 the fees were $1.2 million or 2 per cent.

Pyne Gould has prospective net earnings of $22.2 million for the June 2010 year with Marac contributing $19.6 million on a pre-tax basis. The prospective net earnings represent a P/E of around 13 at the issue price of 40 cents a share.

The big challenge for Marac is to transform its operations from a high-risk finance company, with high margins between borrowing and lending rates, to a low-risk bank where margins are much thinner.

Pyne Gould argues that Marac will lend to the SMEs (small to medium enterprises) where margins are higher. As a result its Marac 2010 forecast represents a return of just over 1 per cent on total assets whereas the two newest domestic owned banks, KiwiBank and SBS (Southland Building Society) Bank have returns on total assets of 0.6 per cent and 0.5 per cent respectively.

Pyne Gould is predicting the best of both worlds for Marac; it will be granted a banking licence but will continue to achieve the high margins usually associated with finance companies.

Pyne Gould will be a success if Marac obtains a banking licence, and transforms itself into a high-margin bank, but $270 million is a massive amount of money if it doesn't achieve these goals.

In this regard the Pyne Gould capital raising is somewhat similar to the 42Below and Xero IPOs as the commercial viability of the proposed business model is highly uncertain and greatly dependent on the expertise of the group's new management team.

* Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.