Prudential Has Chance to Cut Rights-Issue Fees With AIA Buyout

Last Updated May 14, 2010 4:41 AM EDT

If Britain's Prudential insurance company needs another £1bn of capital before the regulators allow it to buy AIA then it should start by slashing the fees it is paying on the rights issue financing the purchase.

As the Pru participates in every UK rights issue â€"- as a buyer rather than seller of shares â€"- this is the opportunity for a permanent repricing of corporate fundraising.

The Competition Commission concluded in 1999 that rights issues were a complex monopoly that inflated fees, but a decade on, the situation has worsened.

When the watchdog investigated City funding the going rate for investment banks underwriting a share issue was 2 per cent of the proceeds with 1.25 per cent paid to sub-underwriters â€"- typically pension funds and insurance companies like the Pru.

The flat rate for raising cash is now variable but the price has gone up. Rio Tinto paid 2.6 per cent on last year's £10bn rights issue, as did HSBC on its £13bn issue. The Rexam packaging group paid 3.6 per cent to raise £350m. Like Rio and HSBC, Prudential ought to be getting a discount for size on the £14bn issue financing its £20bn purchase, but its original plans envisaged paying up to £700m.
City banks take a risk when they underwrite issues -â€" guaranteeing the issuer sells the shares at an agreed price even if the market falls before existing shareholders decide whether to buy -â€" and sub-underwriters share that risk. But while the current financial crisis with its volatile markets might justify charging extra for carrying that risk, it has also undermined companies' ability to negotiate better terms.

It is because firms are over a barrel when raising funds that the monopoly persists. They are more interested in the 97 per cent net proceeds they will receive than the 3 per cent costs. Beggars cannot be choosers so companies with cash crises do not risk haggling and firms seeking finance for acquisitions do not risk leaks by shopping around -- especially when the lead underwriter is usually the investment bank advising on the deal.

But selling new shares at deep discounts to the market price makes the underwriting risk minimal and should shrink the fees accordingly. If shares are offered at 40 per cent below the market price, the market can fall substantially before investors reject the offer. Financial issuers have long employed deep discounts and other companies have now followed. So why are they still paying high fees as well as selling shares cheaply?

Pru has the chance to set an example on its deep-discounted issue. But as the country's main sub-underwriter it receives large fees from other companies' rights offers. Even though it is making a big issue, is the Pru scared of upsetting its City rivals by rewriting the rules?

Or is paying dearly now to protect its own position in future? It would be doing business a better favour by breaking this monopoly now.

(Pic: stevecadman cc2.0)