(Bloomberg Opinion) -- Europe’s big short may face a new challenger. The jumbo cash calls of pandemic-hit companies have been easy prey for hedge funds betting the stocks will fall. But the potential involvement of a sovereign wealth fund in a fundraising by Rolls-Royce Holdings Plc could herald a shift in the balance of power between short sellers and ordinary shareholders.
The iconic U.K. engineer is considering a 2.5 billion-pound ($3.2 billion) capital increase and is talking to state-backed investment vehicles including Singapore’s GIC, the Financial Times reported last weekend. The injection would assuage fears over the company’s ability to withstand the "severe but plausible" downside scenario it described last month.
Rolls-Royce is late to the party. The capital markets well has already had many visitors. The equity rally from March’s lows protected asset managers from redemptions, enabling them to support cash calls from companies sometimes increasing their share count by as much as 20%.
Today, markets are wobbling. Meanwhile, we are seeing requests for cash so large that they can require so-called rights offers — a tortuous, drawn-out process for raising capital in volume. British Airways-owner IAG SA, mall operator Unibail-Rodamco-Westfield and Rolls are all seeking, or considering raising, at least 75% of their market value.
They present tricky propositions. With the novel coronavirus still a public-health menace, these companies’ full recovery prospects may lie beyond the near-term horizon of stock-market investors. Sovereign wealth funds, with their decades-long view and need to make really big bets, will be more easily tempted.
IAG already has a sovereign-backed shareholder in 25%-owner Qatar Airways, which has committed to its share of the 2.7 billion euros ($3.2 billion) the transport company is seeking. But no single investor in Rolls-Royce has more than 10%. A placing to a sovereign fund, assuming U.K. government approval, followed by a rights offer to the enlarged shareholder base would be one way of structuring a transaction.
The entrance of new anchor shareholders into rights offers would put the cat among the pigeons. These deals provide rich pickings for short sellers and it’s been painful for ordinary investors to watch. The desperate companies are soft targets. Rumors start, the firm confirms it may sell new shares, negative momentum builds. An in-principle underwriting agreement with banks follows, final terms undecided. The stock stays under pressure until the equity issue is priced at rock bottom. Hedge funds cover their shorts with the bargain stock and exit. It all seems unnecessarily destabilizing for the company.
The underwriting banks have no incentive to push against this. As buyer of last resort, it’s in their interest that rights-offer shares are priced as cheaply as possible.
IAG’s stock has suffered as lockdowns have resumed. But without Qatar’s backing the situation would surely be more precarious. Quite simply, if a big chunk of a capital increase is spoken for at the outset, there is less scope for short sellers to disrupt the process.
Introducing a sovereign fund may face political complications and obstacles. There is an alternative — just get the company's existing top shareholders to declare support for its cash call from the get-go.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
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