The challenges of underwriting capital raisings in a COVID-19 world - Acquisition Finance/LBOs/MBOs

There has been a flurry of activity in equity capital markets in the wake of ASIC and ASX introducing temporary measures to assist ASX-listed entities raise capital in response to the challenges created by the COVID-19 pandemic.¹

Many of these raisings have been conducted by way of a private placement coupled with an accelerated entitlement issue (which has been either fully or partially underwritten) in order to minimise the amount of time the issuer is exposed to market related risks.

Most notably, the amount of money capable of being raised at the front-end has increased considerably following ASX class waivers lifting an issuer's placement capacity to 25% (up from 15%) and permitting a non-renounceable entitlement offer ratio of greater than 1 : 1.

The recent market volatility, shifting macroeconomic conditions and residual uncertainty regarding the fallout from the COVID-19 pandemic have created new challenges for issuers and underwriters alike when it comes to negotiating underwriting arrangements.

In addition to the greater discounts offered to investors to maximise take-up and reduce the prospect of a shortfall in the level of funding sought, we have seen much greater attention being placed on the following areas:

Due diligence. We expect underwriters to require detailed due diligence enquiries into the issuer's sensitivities to disruption caused by COVID-19 related matters (particularly the potential impact on any previously published profit forecasts, forward-looking statements and intentions with regard to dividends) to ensure such statements have a reasonable basis and can be made with sufficient certainty.
The ability to amend, suspend or terminate material contracts in light of recent financial and economic events will also be considered, as well as the issuer's response plans to unforeseen operational and supply chain disruptions.

Residual uncertainties relating to the issuer's operating and financial condition may also lead to further disclosure being provided (such as through an investigating accountant's report) in order to bolster investor confidence and assist with marketing the capital raising.

Undertakings. A customary requirement of underwriters is that the issuer preserves the 'status quo' for an agreed period after completing the capital raising. These undertakings usually include a moratorium on activities outside the ordinary course of business, and typically extend anywhere between 60 and 180 days after completion of the capital raising.
Concepts like conducting business 'in the ordinary course' have always been somewhat opaque, but they indeed become even more fluid as businesses respond to what seems like an ever-evolving landscape in response to the COVID-19 pandemic. In any event, the pace of change we have seen over the last month makes a 180-day period seem like a lifetime!

In these uncertain times, we have been advising issuers to think carefully and foreshadow events that may need to be undertaken within the period of the moratorium and, where possible, preserve the necessary flexibility to reasonably and prudently respond to a material change in operating or financial conditions arising out of the coronavirus pandemic.

Termination events. Underwriting agreements often contain 'market out' clauses enabling the underwriter to terminate in circumstances where a defined market variable (such as the price of a particular commodity or index) falls below a specified level (typically around a 10% fall). Whilst market movements of such a level would typically be unusual and considered extreme, in March 2020 we saw intraday movements in global stock markets around these levels.
In entitlement issues where the retail component is completed some weeks after the capital raising is announced, 'market out' clauses expose the issuer to significant market risk.

The accelerated capital raising structure has been used in many recent capital raisings as a practical way for issuers to mitigate this market risk, as it allows the institutional component of the capital raising to settle in a compressed timeframe.

Another way to seek to reduce this risk is to ensure that intraday movements cannot provide the trigger, as well as to require the market to trade below the minimum level for a minimum period of time (rather than a spot test).

Perhaps of more interest are the qualified termination events which require the relevant event to also have a materially adverse effect on the success, settlement or marketing of the capital raising.

Both issuers and underwriters should remember that the benchmark for assessing whether such a change has occurred are the circumstances existing at the time of execution of the underwriting agreement. This may make it more difficult to establish that there has been a material adverse change given the uncertainty which issuers are already faced with at the time of announcement of the capital raising.

Ultimately, the parties will need to reach a position that will adequately protect the issuer from 'hair-trigger' termination events (where what can be a 'hair trigger' is being re-defined) while at the same time giving sufficient comfort to the underwriter that it can exit an arrangement in circumstances where it would not be commercially viable to proceed to underwrite the issue.

Both issuers and underwriters need to be alive to the fact that what might have been 'standard' or 'customary' in underwriting arrangements in the past may need to be revisited, in an effort to recalibrate to what has become the new normal post the COVID-19 outbreak.

Footnote

¹Corrs recently acted for Southern Cross Media Group Ltd, Shopping Centres Australasia Group and Dacian Gold Ltd on their recent capital raisings.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.