Question

8. Santos Limited has expanded its exploration program and has decided to fund the expansion through the issue of additional ordinary shares to its existing shareholders on a pro-rata basis of one new share for each 5 shares held. The issue price is $11.75 per share and the current market price is $11.95. The financial advisers to the corporation have recommended the use of an underwriting facility. The board of directors has noted that the underwriting facility has an outclause if the market price drops below $11.45. Having regard to this information, answer these questions. (a) What type of issue is Santos Limited making to its shareholders?

(b) What is an underwriting facility, and why might Santos use such a facility?

(c) Why might Santos use an underwriter?

Answer 1

(a) What type of issue is Santos Limited making to its shareholders?

1. The issue by Santos Limited of additional ordinary shares to existing shareholders

at a ratio to the existing shareholding is a pro-rata rights issue.

2. In the above example the shareholder will receive one new share for each five

shares currently held. The new rights shares will be issued at $11.75 each.

3. The issue price of $11.75 is at a discount to the current market price, partly as an

incentive to shareholders and partly to allow for the expected fall in the price due

to the dilution effect of the additional new shares.

4. The right may be renounceable and listed on the stock exchange; the shareholder is

entitled to sell that right before the exercise date; otherwise the right may be non-

renounceable.

(b) What is an underwriting facility, and why might Santos use such a facility?

1. A contractual undertaking by an underwriter to purchase securities that are not

fully subscribed to by the existing shareholders; for example, the underwriter has

agreed to buy any surplus Santos rights issue shares providing the market price

remains above $11.45.

2. In a large issue of securities there will typically be a group of underwriters and sub-

underwriters, each accepting a portion of the underwriting exposure.

3. The underwriters will charge a fee for this service.

(c) Why might Santos use an underwriter?

1. The underwriters will provide advice on:

(i) the structure, pricing, timing and marketing of the issue.

(i) the allocation of the securities between underwriters, investors and markets.

2. Underwriting an issue provides the corporation with a much higher level of

certainty that it will raise the necessary funds from the issue, particularly in times of

market volatility.