Lloyds Rights Issue: Just one small point, Darling

I see that this week’s Guardian Money letters page includes the clarification that, as I’ve also pointed out, the Lloyds rights issue does amount to “about 50p for each current share”.

The Guardian also publishes a letter (sorry, the online version of their letters page has no internal links, so you’ll have to scroll down), noting how the Equitable Life “was operating a Ponzi scheme under the very noses of the regulators”. I couldn’t have, and, in fact, didn’t put it better myself.

Hey, here’s an idea. If Guardian Money doesn’t really know what it’s talking about, why don’t they simply list issues in the news, inviting correspondence for publication the next weekend? It’d save on journo costs. I doubt the other papers are any better – I’m picking on the Guardian because that’s the paper I take, so really, guys, this is all a vote of confidence!

Anyway, about this 50p.

Late last Thursday, I think it was, I thought I’d check the exact amount due in the rights issue per current Lloyds share held. And I found that the shares are being sold a little cheaper to the Treasury.

The reason I checked is that there are (at least) two slight complicating factors in the Prospectus.

First, I noticed that:

“Ordinary Shareholders in the United States or any other Restricted Jurisdiction will, in any event, not be able to participate in the Rights Issue.” (section 3.2, p.32).

If such shares didn’t qualify for rights (which is not what’s stated, though is not excluded by the statement), then obviously the rest of us would have to put in a bit more to raise the £13.5bn. But one would imagine the rights would end up being sold in the market, which is what p.77 of the Prospectus seems to say (Section 15: “What should I do if I live outside the UK?”). So shareholders in Restricted Jurisdictions shouldn’t be a problem.

Second, there are a small number of Limited Voting (LV) shares – 79 million, compared to over 27bn – in fact ~27,162 million – Ordinary Shares. These LV shares also have an entitlement to rights. What I don’t know, though, is how much these LV shares are worth. If each is worth much more than an Ordinary Share, and, more to the point, if the holder of each contributes significantly more than 50p to the rights issue, then the rest of us would have to put in a bit less than 50p.

On the other hand, the Prospectus clearly states that they will issue up to 90 billion Ordinary Shares. The lowest price the new shares could be issued for is 15p, and 90bn * 15p is precisely £13.5bn.

So it seems the £13.5bn is indeed being divided equally amongst the 27bn shares – 27,161,682,366 to be exact – so shareholders will have to put in 49.70p, to 2 decimal places.

Nevertheless, I thought of another way of checking the 50p figure. I realised it was possible to work out how much the Treasury is paying for new shares in the Rights Issue. Their press release on the topic notes they’ll be “investing £5.7bn net of an underwriting fee”.

According to the Prospectus (p.104), the taxpayer currently owns 43.43% of Lloyds’ Ordinary Shares (the Treasury press release gives 43%, which is disappointingly imprecise).

43.43% of the shares comes to 11.8bn – 11,796,318,652 to be as precise as we can.

£5.7bn divided by the number of shares the Treasury holds, comes to 48.32p, not 49.7p.

My first thought was that, since the proportion of shares owned by the Treasury was rounded to 43%, perhaps the £5.7bn is a rounded figure too. But even if the real figure was £5.7999999bn, that would only be 49.17p a share, significantly less than our 49.70p.

In fact, as the holder of 43.43% of the shares, the Treasury should be putting in £5.86305bn, not “£5.7bn”.

Then I paid attention to the words after the figure £5.7bn in the press release: “net of an underwriting fee” [my stress].

Yes, what appears to be happening is that the Treasury is underwriting its own share purchase!

And, sure enough, the Prospectus has this to say (p.216):

“7.2 HMT Undertaking to Subscribe

Under the HMT Undertaking to Subscribe, subject to certain terms and conditions, including that the Resolutions relating to the Rights Issue and the HMT Transactions are passed, HM Treasury has irrevocably undertaken to procure that the Solicitor for the Affairs of Her Majesty’s Treasury (as nominee for HM Treasury) (i) votes in favour of all of the Resolutions in accordance with the recommendation of the Board (except for Resolution 4, as set out in the notice of General Meeting, regarding the HMT Transaction) and (ii) takes up its rights to subscribe for all of the New Shares to which it is entitled under the Rights Issue, at or prior to 11.00 a.m. on 11 December 2009, each at the Issue Price. Conditional upon (ii) above, the approval of Resolution 4 by the Ordinary Shareholders and the receipt by the Company of the aggregate subscription proceeds payable by HM Treasury (the ‘‘HMT Subscription Proceeds’’), the Company has agreed to pay to HM Treasury (or to such other person as HM Treasury may direct) the HMT Commitment Commission, being a fee equal to: (A) the Base Fee multiplied by the aggregate number of New Shares for which it has subscribed, plus (B) the Per Share Discretionary Fee multiplied by the aggregate number of New Shares for which HM Treasury has subscribed, in consideration, amongst other things, for the undertakings given by HM Treasury in the HMT Undertaking to Subscribe. The HMT Undertaking to Subscribe contains certain representations and warranties and indemnity provisions in favour of HM Treasury which are the same as those given in favour of the Banks (and certain other indemnified persons) under the Rights Issue Underwriting Agreement.” [my stress].

Remember that £13.5bn? Well, as I had to allow for in calculating the “TERP”, only £13bn of it goes to Lloyds.

If we calculate how much the government is paying on a basis of the total rights issue being £13bn and not £13.5bn then 43.43% is £5.6459 which is much closer to £5.7bn. Not all of the £500m will be the underwriting fee. If the Treasury is putting in exactly £5.7bn (and owns exactly 43.43% of the shares), then that implies the issue will raise £13.12bn (rounded) including arrangement fees, but net of underwriting costs. The latter therefore come to around £388m. Shocking.

My understanding is that in fact this little perk is not special to this rights issue, nor to HM Treasury. Large shareholders are routinely underwriting their own subscriptions to share issues.

Now, all this really represents is an early commitment to subscribe to the issue.

Let’s just consider how much this is worth. The issue will be at a ~40% discount to the TERP, as discussed last time. As we saw, the TERP will be around 55p, and the new shares issued at ~33p.

Is there any real chance of the share price falling below 33p before the completion of the rights issue?

Not really. Cyclone Lehman has passed through the markets and all is now calm. Lloyds raised £4bn at 38p a share back in April, when the recession and its own position looked much worse than it does now.

More to the point, would I have taken the same deal as HMT to save my share of the £388m? Yes, I would.

Before Darling got his feet under the desk at Number 11, there was a principle that shareholders were protected by “pre-emption rights”, that is, existing shareholders had to be offered the same deal offered to new shareholders. Similarly, the interests of minority shareholders are supposed to be protected from the big guys. Now, an ignorant media (and Vince Cable) eggs on the government to act exclusively in the interests of “the taxpayer”. In fact, companies must be run in the interests of all shareholders. That’s why they are legal entities. In using its stakes in the banks to impose stealth taxes on the organisations, the Treasury is dangerously close to indulging in the same sort of behaviour that put Conrad Black behind bars.

Mr Darling, might I perhaps have the temerity to suggest that, rather than whinging about bankers’ bonuses, a better strategy would be to examine some of the ways in which business insiders make massive amounts of easy money at the expense of, very often, the private shareholder, among others? And underwriting rights issues isn’t even the worst offence. Start by looking at the bankruptcy process – e.g. Telewest, Cobra Beer, Jessops and Woolworths and list the winners and losers…

There is a massive conflict of interest if large shareholders receive underwriting fees for rights issues. I have no idea whether £388m is an objectively reasonable figure or not. But I do know two things:
1. The holders of large blocks of shares who also act as underwriters – including the Treasury in this case – have no incentive to question the underwriting fee.
2. I wasn’t offered the chance to underwrite my own share purchase – i.e. commit a few weeks early – which I would quite happily have done. I’d have liked a “Commitment Commission” too, Mr Darling.

Small shareholders can work out how much the under-writing will cost them: it’s £(~388m * no. of current shares)/total number of shares i.e. ~27bn, a bit over 1.4p per share or ~£14 per 1,000 shares. Adds up, doesn’t it?

No wonder investment bankers are rolling in money when the Treasury – far from ensuring fair play – is happy to be complicit in yet another systematic mugging of Joe shareholder.

And what’s more, it’s not difficult to think of better ways of carrying out rights issues.

Lloyds Rights Issue: Timetable and TERP

This is my third post on the topic of Lloyds upcoming rights issue. My aim is to provide a little clarification for those affected. Why am I doing this? Despite everything, I still believe in a “share-owning democracy”.

The Guardian’s Patrick Collinson wrote this recently:

“An equitable figurehead

In recruiting Honor Blackman as a Joanna Lumley-esque figurehead, the Equitable Members Action Group has chosen well. With-profits annuitants such as Blackman, who had no choice but to stay with Equitable, have suffered more than any other category of policyholder. The others were given a choice in 2000 to get out with a 10% cut in policy values. Those that didn’t take it want compensation galore instead. Are they really that deserving of taxpayer money?” [my stress]

Maybe I’m a bear of little brain, but the Equitable Life non-GAR with-profits policy-holders have had a large chunk of their assets arbitrarily confiscated – a court put the rights of GAR holders above theirs. If this doesn’t deserve compensation, I don’t know what does. More another time.

The lesson I take from this is that you’d better look after your own finances because you can’t trust the media to look out for you when the pros screw up.

When Lloyds announced their upcoming rights issue my initial reaction was to whinge about the complexity of “deferred shares”, which I concluded are worthless, just a device to get round some stupid rule.

I also noted on that first post and subsequently that you can determine how much cash you’ll need to take up your rights. You’re going to need ~50p per share you hold going into the rights issue.

I have no idea why Lloyds didn’t spell out in the various documents they’ve issued about the rights issue that you’ll need to find ~50p per existing share to take up your entitlement to new shares. If I may be permitted to give them some feedback as a shareholder, my opinion is that it would have been a good idea to specifically include the amount of money shareholders would need to find. Perhaps those involved and the officers of any other company doing something similar in future could bear this point in mind.

In my second post on the subject I also presented the argument that a rights issue can temporarily depress a company’s share price so might be a good time to buy shares either by subscribing to the issue or otherwise. [Nothing I write on this blog should be taken as financial advice].

From the search terms that are being used to reach this blog, there are two other significant areas of confusion: the timetable and the use of the term “theoretical ex-rights price” (TERP) to determine the issue price of the new shares.

Timetable

As I understand it, for the retail investor there are only 3 key dates and the first of these appears to be another anachronism (this whole process could do with a bit of simplification):

- 20th November (Friday): the “Record Date” for entitlement to receive rights. If you’re planning to buy shares near or after this date, then, if I were you, I’d check with a financial adviser or stockbroker as to whether the deal will be in time to qualify and whether there’ll be any extra bureaucratic hassle. The Prospectus says this:

“7 If I buy Ordinary Shares after the Record Date will I be eligible to participate in the Rights Issue?
If you bought [sic] Ordinary Shares after the Record Date but prior to 8.00 a.m. on 27 November 2009 (the time when the Existing Ordinary Shares are expected to start trading ex-rights on the London Stock Exchange), you may be eligible to participate in the Rights Issue.
If you are in any doubt, please consult your stockbroker, bank or other appropriate financial adviser, or whoever arranged your share purchase, to ensure you claim your entitlement.
If you buy Ordinary Shares at or after 8.00 a.m. on 27 November 2009, you will not be eligible to participate in the Rights Issue in respect of those Ordinary Shares.”

So what’s the point of the Record Date if it’s not a real deadline?

- 27th November (Friday), 8am: rights created and can be traded or exercised. This is when I’d expect them to appear in (online) nominee accounts.

- 11th December (Friday), 11am: rights must be exercised by this time, though if you have a nominee account they’ll probably advise you of a deadline earlier than this. The new shares can be traded from start of business on the Monday (14th December).

TERP

The Lloyds Prospectus (p.6) implies that the:

“…Issue Price [will] be set at a 38 per cent. to 42 per cent. discount to TERP…”

They also define the TERP as:

“the theoretical ex-rights price of an Existing Ordinary Share calculated by reference to the volume weighted average price on the London Stock Exchange’s main market for listed securities of an Existing Ordinary Share on 23 November 2009″.

Got that?

I thought I understood how to work out the TERP, but tried to check anyway. Wikipedia’s entry is little help. It doesn’t seem to me to contain any falsehood, but then it doesn’t provide a lot of information either.

Unfortunately, Wikipedia references something called Investopedia which has this to say:

“Although the stock price is not likely to change immediately following the new rights issue, it will change as the rights expiration date approaches.”

Rubbish. No wonder we’re all confused!

The whole point is that as soon as the existing shares are split into ex-rights shares and (nil-paid) rights (at 8am on 27th November in the case of Lloyds), the (ex-rights) share price adjusts – to the TERP – to reflect the split. The rights should theoretically trade at approximately the TERP minus the subscription price for each right (i.e. how much you have to pay to exercise the right). Once all the rights are exercised, which they will be, since rights issues are underwritten, the new shares will be identical to the existing shares and should trade at the TERP, plus or minus the effect of any changes in sentiment due to events after the start of the rights issue or just because sentiment changes.  I say “should” trade at the TERP, because there’s also the effect of the additional supply of shares, which may depress the share price below the TERP, as I discussed last time.

So what would we expect the TERP to be for Lloyds?

TERP Calculation

This is how I think the TERP should be calculated.

At present the shares are trading, handily, at exactly 90p. If we round down to 27 billion in circulation, Lloyds is currently worth £24.3bn.

The rights issue involves putting in more money (£13.5bn less £500m expenses) and creating more shares – we don’t know how many yet.

After the rights issue Lloyds should theoretically be worth £(24.3+13)bn = £37.3bn.

The TERP depends on how many new shares are created. For example, if the new shares are priced at 50p, there will be another 27bn. There will therefore be 54bn in circulation after the rights issue and each share would be worth £37.3/54 = ~69.1p.

In this case the rights would be expected to trade at around 19.1p.

If, in this example, the rights were trading at less than 19.1p or the shares at less than 69.1p after the start of the rights issue, then the implication is either Lloyds’ prospects have changed, or the rights issue has reduced the share price.

Lloyds say they want the rights price to be at a ~40% discount to the TERP. 50p is therefore too much (it’s more than 0.6*69.1p). You could iterate to an appropriate price but I expect they did some algebra:

No. of shares after issue = 27bn + 13.5bn/P (where P is the price of the rights issue)

TERP = (Share price before issue (known, let’s take this to be 90p, as now) * 27bn + £13bn) / no. shares after issue

P = 0.6 * TERP

Therefore, P/0.6 = £(24.3+13)/(27 + 13.5/P)

P (27 + £13.5/P) = £37.3*0.6

27P + £13.5 = £22.4

P = £(22.4 – 13.5)/27 = £8.9/27,  i.e. 33p.

and TERP = 33p/0.6 = 55p

Check: No. shares after issue = (27 + 13.5/0.33)bn = 67.9bn

TERP = £(37.3/67.9) = 55p

Easy, peasy! [But see Note below]

So, if Lloyds shares are trading at 90p on 23rd November (the date Lloyds is using for their calculation), I’d expect the the rights to be priced at around 33p (I’ve indulged in a little rounding, so let’s not try to be too accurate now) and the TERP will be around 55p.

It’s quite possible I’ve made a horrendous error (or even more than one).  If so, I’ll be happy to post a correction if someone points it out. [22:00 12/11: I've already corrected a small error I spotted myself!]

[Note (18:30 24/11): As discussed in a later post, Lloyds have actually gone for a rights price of 37p, implying a "TERP" of ~60.24p. The difference from my estimate is due to a number of factors:
- some rounding down on my part;
- my assumption of a 90p share price before the issue. Lloyds took the closing price of 91.47p on 23rd (even though they said they'd take the average share price that day);
- Lloyds priced the rights issue towards the bottom of the 38-42% range of discount to the "TERP" they'd announced - ~38.6% - whereas I assumed a 40% discount;
- I deducted the £500m in fees from the proceeds of the rights issue - this shouldn't really have been done (and has a significant effect, showing how much those fees are costing shareholders), but then again, the only true TERP is that calculated on the closing price just before the rights are created.]

Lloyds Rights Issue: A Reason to Buy?

I’m rather surprised by the number of hits I’m still getting on a previous post, which noted the unnecessary complexity of the upcoming Lloyds rights issue and the way it’s been presented. I rather thought the weekend papers would clear the matter up, so was unsurprised to read the Guardian Money front page headline “Buddy, can you spare me £13.5bn?”. I immediately followed the injunction “>>Pages 4-5″ and fast-forwarded to read Jill Treanor’s examination of the “implications for small shareholders” and Patrick Collinson’s suggested “plan of action”.

I have to say I was rather disappointed.

Collinson suggests that:

“You got some Halifax shares when it floated. Now we at Lloyds want you to cough up a couple of hundred quid (we won’t tell you the exact sum till later)…”

[my stress]

Treanor also sheds considerable darkness on the point.

Now it simply isn’t true that Lloyds haven’t advised the exact sum investors will have to “cough up” (though they could have been clearer). As I pointed out last time, it’s quite simple: Lloyds wants £13.5bn, which will be divided equally amongst the ~27bn shares in circulation. That’s ~50p a share. If you own 1000 shares you’re going to be asked to put in £500. How many new shares you’ll get and at what price each is yet to be determined.

This is actually a step forward in the organisation of rights issues. The problem is that when a company announces it is going to sell a lot of shares, the price tends to fall – supply and demand – since not every share owner will be able to and want to put more cash into Lloyds equity. By delaying the announcement of the price of the new shares until the last minute, Lloyds has somewhat reduced the risk of the share price falling below the rights issue price, which would be a disaster, since, if you could just buy shares in the market for a lower price, there would be no point taking up the rights issue. The under-writers would end up with all the new shares.

What worries me most about Collinson’s comment piece and Treanor’s Q&A is that they omit part of the case for participating in the rights issue. What I’m about to say should not be construed as financial advice, but there are obvious reasons why a company’s share price might be depressed ahead of a rights issue and that in general a rights issue may be a good opportunity to invest.

The key point is supply and demand for the shares, that is, precisely what Lloyds is worrying about and the reason for the confusion about the offer price for the new shares. Many investors – funds or individuals – may simply be unable to put more money into Lloyds shares. They may just not have the cash. Or, especially if they’re a fund, they may not want Lloyds shares to rise as a proportion of their portfolio. This could even be against the rules of the fund.

Of course, some investors, such as index tracker funds, may be compelled to increase their holding in Lloyds in line with the increase in volume of its equity. But it’s difficult to think of a fund that would be compelled to take up more than its share of rights.

Therefore, it’s often argued, a rights issue is a good time to buy, because there is a surplus of sellers of the stock.

As Jill Treanor points out, you can sell some or all of your rights in the market, for example, to raise enough cash to take up the rest of your rights, a practice known as “tail-swallowing”. Such selling activity will tend to make the rights cheaper. But it’s important to understand that if the price of the rights falls, then so does the price of the existing shares. The reason is the (arbitrage) opportunity to simply sell shares and buy the rights.

Example: To simplify a little, say Lloyds shares fall to 60p when rights have been given to all the shareholders. The rights might entitle you to buy new Lloyds shares for 40p each (so you’d get 5 for every 4 shares you held at the qualifying date for the rights issue) so should sell for about 20p each (since once you’d put in the 40p you’d receive a new share exactly equivalent to the existing shares). If so many people sell their rights that the price is not 20p but drops to (say) 18p, then someone could sell shares for 60p, buy rights for 18p, subscribe to the issue for 40p and make (60 – 18 – 40)p = 2p a share. Do this for a few million shares and you’re building up a tasty bonus pot! What happens when people sell the shares to buy the rights, of course, is that the share price tends to fall until the price of the shares and the price of the rights are aligned again.

So, according to this argument, it may be a good time to buy Lloyds shares, e.g. by subscribing to the rights issue.

It might also be worth noting that Lloyds stated that it will not pay a dividend for 2 years. This may be another reason why some investors (income funds) will not want to hold the shares, though they may already have sold their holdings in the stock.

Of course, there are many reasons why it could turn out to be a bad time to buy Lloyds. They might screw up. Or we might experience the dreaded double-dip recession. And if so many people decide it’s a good time to buy Lloyds, this will push up the price and make it a bad time to buy! Though it is the largest rights issue in the UK to date…

At the end of the day, investors must make up their own minds, and, as I say, I’m not providing financial advice. Patrick Collinson (or his editors) are bold enough to allow themselves a headline “Lloyds looking unattractive” (or “Lloyds rights issue looks distinctly unattractive” in the online version). I just feel investors might also want to take into account the argument that rights issues can be a good time to invest.

Disclaimer: I worked for Lloyds in the early 1990s and own some Lloyds shares.

Lloyds Rights Issue complexity: Um, why don’t we just change the rules?

The upcoming Lloyds rights issue is in fact quite simple. They are giving shareholders the right to buy ~50p worth of new shares for each of the currently existing shares they hold. The new shares will be offered at a discount, but their price has not yet been set, so, obviously, you cannot yet determine how many new shares you can buy. But you’ve been told, albeit somewhat cryptically, what you need to know right now: if you want to take up your rights, you’re going to need to find 50p for each share you own when the rights issue process starts on 20th November. [Summary paragraph added 8:45am 4/11/09].

But is it just me or is the organisation and presentation of this rights issue more complicated than it needs to be? [Reworded 8:45am 4/11/09].

I quote in full section 10 of Lloyds’ announcement of its rights issue:

“10 Share Subdivision

Under the Companies Act, it is not permissible for a company to issue shares at a discount to their nominal value, which, in respect of the Existing Ordinary Shares is currently 25 pence per share. It is proposed that the Company carries out the Share Subdivision which will reduce the nominal value to 10 pence per share. This provides the Company and the Joint Bookrunners with greater certainty that the Issue Price will be able to be set at a 38 per cent. to 42 per cent. discount to TERP [the Theoretical Ex-rights Price, which itself depends on the number of new shares being issued, so a bit of algebra is needed to determine the issue price for 38-40% discount based on the current trading price of the existing shares] irrespective of market conditions. The Board believes that the Share Subdivision also provides the Company access to the best available underwriting structure and terms. Although no decision has currently been made as to the Issue Price, in no circumstances will the Issue Price be below 15 pence. As noted in paragraph 8 of this letter, the Issue Price is expected to be announced on 24 November 2009, two days before the General Meeting. The Proposals are conditional on, amongst other things, the completion of the Share Subdivision.

It is proposed that, pursuant to the Share Subdivision, each existing Ordinary Share of 25 pence in issue at the close of business on the date of the General Meeting will be subdivided into one ordinary share of 10 pence in the capital of the Company (a “10p Ordinary Share”) and one deferred share of 15 pence in the capital of the company (a “Deferred Share”). The purpose of the issue of Deferred Shares is to ensure that the reduction in the nominal value of the Ordinary Shares does not result in a reduction in the capital of the Company.

Each Ordinary Shareholder’s proportionate interest in the Company’s issued ordinary share capital will remain unchanged as a result of the Share Subdivision. Aside from the change in nominal value, the rights attaching to 10p Ordinary Shares (including voting and dividend rights and rights on a return of capital) will be identical in all respects to those of existing Ordinary Shares. No new share certificates will be issued in respect of the 10p Ordinary Shares as existing share certificates for existing Ordinary Shares will remain valid in respect of the same number of 10p Ordinary Shares arising from the Share Subdivision. The number of Ordinary Shares of the Company listed on the Official List and admitted to trading on the London Stock Exchange’s main market for listed securities shall not change as a result of the Share Subdivision. The Share Subdivision will not affect the Group’s or the Company’s net assets. Consequently, the market price of a 10p Ordinary Share immediately after completion of the Share Subdivision should, theoretically, be the same as the market price of an Ordinary Share immediately prior to the Share Subdivision.

In addition, it is proposed that, pursuant to the Share Subdivision and as required by Article 3.1.4(i) of the Articles of Association, each existing Limited Voting Share of 25 pence in issue at the close of business on the date of the General Meeting will be subdivided into one limited voting share of 10 pence (a “10p Limited Voting Share”) and one Deferred Share. Aside from the change in nominal value, the rights attaching to 10p Limited Voting Shares will be identical in all respects to those of existing Limited Voting Shares. No new share certificates will be issued in respect of the 10p Limited Voting Shares as existing share certificates for existing Limited Voting Shares will remain valid in respect of the same number of 10p Limited Voting Shares arising from the Share Subdivision.

The Deferred Shares created on the Share Subdivision becoming effective will have no voting or dividend rights and, on a return of capital on a winding up of the Company, will have the right to receive the amount paid up thereon only after Ordinary Shareholders have received, in aggregate, any amounts paid up thereon plus £10 million per Ordinary Share.

No share certificates will be issued in respect of the Deferred Shares, nor will CREST accounts of shareholders be credited in respect of any entitlement to Deferred Shares, nor will they be admitted to the Official List or to trading on the London Stock Exchange or any other investment exchange. The Deferred Shares shall not be transferable at any time, other than with the prior written consent of the Directors. The rights attaching to, and restrictions upon, the Deferred Shares are set out in Resolution 6.

At the appropriate time, the Company may repurchase the Deferred Shares, make an application to the High Court for the Deferred Shares to be cancelled, or cancel, or seek the surrender of the Deferred Shares using such other lawful means as the Directors may determine.”

Got that? You’ll be tested on it later!

In fact, all section 10 says is that to get round some stupid rule, and in case Lloyds shares fall before the rights issue completes, we’re all going to be issued with “deferred shares”. These are totally worthless. I just hope they don’t actually show on my trading account, cluttering up the screen and statements.

Frankly, who cares about the nominal value of shares? And, if the rule that companies can’t issue new shares at below the nominal value of existing shares is so easily circumvented, does it really have any point? Maybe the law could simply be changed to add “unless approved at an AGM”.

I’d rather the army of accountants and company lawyers running large companies were employed making sure the business doesn’t screw up, not worrying about worthless deferred shares. Someone was obviously paid to write the paragraph that ensures the deferred shares are worthless. On the other hand, maybe it was worth it for the amusement value. I like it so much I’ll quote it again, this time with a bit of emphasis:

“The Deferred Shares created on the Share Subdivision becoming effective will have no voting or dividend rights and, on a return of capital on a winding up of the Company, will have the right to receive the amount paid up thereon only after Ordinary Shareholders have received, in aggregate, any amounts paid up thereon plus £10 million per Ordinary Share.”

Perhaps they should index that £10 million to RPI. We might experience hyperinflation.

Lloyds is also waiting till the last minute before telling us what the issue price of the new shares will be, in case the short-sellers get their teeth into the situation. Actually I don’t care very much. What I want to know is how much I’m going to have to put in for each share I own. Then I can calculate the total amount I need to find. Shareholders are being asked for about 50p per share they own at the record date for the issue (20th November), calculated by dividing the amount to be raised (£13.5bn) by the number of shares in circulation at the moment (just over 27bn, a number which won’t change materially over the next couple of weeks). Lloyds’ announcement could easily have included the exact amount as a headline (I haven’t read all 200,000 pages of the documents they’ve issued today).

Rights issues remain dysfunctional as I explored here, here and here around 18 months ago (when HBoS was passing a hat around, ironically enough). All that’s been done is to try to speed the rights issue process up, which introduces new problems: the regulators haven’t speeded up the process of moving money about, and the post, for obvious reasons, is even less reliable right now (let’s hope we can all exercise our rights online or by telephone, eh?). As I said in my previous posts on this topic, it must be possible to devise a way of raising funds from shareholders that isn’t vulnerable to attack by short-sellers. Such a scheme would surely save on underwriting fees, for starters. Lloyds will only raise £13bn net from its £13.5bn rights issue. I can live with putting money into basically sound companies that need it, but it sticks in the craw that so much disappears in transaction costs (and in this case, a windfall tax in all but name). Especially when I’m not going to get any dividends for another 2 years!

Virgin on the Ridiculous – and All Tied Up

Richard Branson had an entertaining comment piece in the FT today. He was complaining about Sky’s dominance of the premium pay TV channels – predominantly sports and movies. Quite right too, the UK TV market is a big mess. Both the BBC and Sky stifle competition.

One point Branson made tickled me. If the market were functioning better, he claimed:

“Those who do not wish to commit to a 12-month subscription but are willing to pay for some TV channels will be more readily able to do so.”

Readers will remember that one of my whinges about Virgin Media was that they locked me into a 12-month contract. I presume Branson won’t mind if Virgin Media as well as Sky have their wings clipped in this regard.

But what really had me rolling around on the floor was the Bearded One’s description of Ofcom’s proposal, which, naturally, he wholeheartedly supports:

“Ofcom has proposed … making Sky sell its premium channels to other operators at a fair, wholesale price. This would be an excellent result for consumers because it will enable each pay-TV operator to com­pete based on its different strengths. Services will be developed that appeal more closely to the preferences of different customers. For instance, those who do not want, or cannot have, a satellite dish will not need one. … New market segments and more innovative and compelling consumer offers will appear. And they will cost less. Under Ofcom’s proposals, some operators could plan to retail Sky Sports 1 at a price more than 20 per cent below the lowest price that channel can currently be bought from Sky.” [my emphasis]

Absolutely hilarious.

Basically I support this vision – but this isn’t the way to go about changing the industry.

The point is that if Ofcom do this (and how they dream up the wholesale price is beyond me), then it makes no sense whatsoever for Sky to remain as both a service-provider and a channel-provider.

Separating these functions (for all broadcasters, BBC take note) – i.e. splitting Sky up into a service-provider and a separate channel/content-provider – should be the starting point of regulation, not a consequence of it. Breaking down vertical integration in this way is a central pillar of “managed markets”, part of my new political-economic philosophy of “constrained capitalism”.

The central argument is that if I can choose the technology that delivers my TV service and the channels I purchase as entirely separate steps, as Branson describes, then I have 2 dimensions of choice, not one.

There are numerous markets where our dimensions of choice are limited by dominant suppliers. Supermarkets is one. I gather from the hits on my rant complaining about the Cambridge Sainsbury’s misguided promotions and on my wide-ranging discussion of attempts to reduce competition by blocking Tesco in Mill Road and of self-checkout tills in supermarkets, that supermarkets are what the world wants to read about. Back in March when I wrote those pieces I meant to add some further comments complaining about how the Cambridge Sainsbury’s in particular has been gradually replacing branded products with subtly inferior own-brand goods. In my opinion, the texture of Kelloggs’ Sultana Bran is somewhat more dissimilar to that of cardboard than is Sainsbury’s equivalent product. If Kelloggs’ product is good enough for Chris Hoy, then it’s good enough for me. Besides, the Kelloggs box fit in the space in my cupboard in Cambridge and the Sainsbury’s one did not. It was very inconvenient to have to make periodic trips to Asda to stock up on Kelloggs’ Sultana Bran when Cambridge Sainsbury’s decided to just stock their own brand.

The point is that when supermarkets used to stock only branded goods, you had two dimensions of choice: where to shop and what to buy when you got there. The supermarkets specialised in the business of retailing and their suppliers in making the best products.

But what the supermarkets have done over the years is reduce the choice to one: where to shop. Larger stores, the institution of the weekly shop by car and a battle to monopolise the best locations have made it very difficult for shoppers to choose different products at different stores.

Own-brand products are a way of capitalising on “owning” the customer. Why let suppliers have some of the profits? Even if an own-brand alternative is slightly inferior shoppers are unlikely to go to a rival just for one or two items. And after a while they may forget they preferred the brand. Of course, it may not be necessary for the supermarket to ditch the branded product anyway. The threat of introducing a generic alternative may be enough. It must, surely, allow the supermarket to improve the terms of supply and increase their profits.

In the news this week, though is the OFT’s ruling in favour of the status quo on tied pubs. Clearly the practice must increase the landlords’ profits, since, as the FT reports:

“The OFT ruling on beer ties, which obliges pub tenants to buy their beer supplies from their pub landlords at often above-market prices, boosted shares in Punch Taverns and Enterprise Inns by 14 and 23 per cent respectively.”

I doubt the stockmarket is mistaken: if the practice is good for the landlords it must be bad either for the tenant (i.e. the pub manager, referred to in common parlance as the “landlord” – don’t get confused) or the customer. Probably both.

It seems to me fairly obvious that restricting the degrees of choice by the customer must allow the landlord to improve profits. Not all customers are going to go elsewhere for a different pint of beer, though they may well buy something different if it were on offer in their local.

Different industries may have the same feature – an anti-competitive form of vertical integration – but there are peculiarities to each. In the pub business, the landlord is a monopoly supplier to the tenant. It is therefore beyond me how we can find a Simon Williams, “senior director of the OFT” saying, according to the FT, that:

“… it [is] not in the pub owners’ interests to overcharge landlords for their beer. ‘Any strategy by a pub-owning company which compromises the competitive position of its tied pubs would not be sustainable, as this would result in a loss of sales. Pub-owning companies are not therefore protected from competition by virtue of the supply ties agreed with their lessees.’ ”

No, no, no! This is mindblowingly dumb. 101 economics (again): a monopolist does not maximise profits by fully satisfying “demand”. A few seconds thought verifies the sheer mindblowing dumbness of the OFT’s assertion: by their logic the pub owners would reduce beer to a fraction above cost to sell as much as possible. No. The pub owner has an incentive to increase the price of beer until the additional profit is outweighed by the sales that are lost. As I said, many people choose their pub on criteria other than the beer stocked and its price, so the tied pub owner has much more scope to increase prices than an independent beer producer. If customers don’t like it they have to go out in the rain: they can’t simply choose a beer from a different pump.

The Guardian, I now see, also reports the OFT’s decision. As well as the quote above they report some more absurd statements from Simon Williams:

” ‘The interests of the pubco and lessee are aligned.’

This is a bizarre thing to say. In any supply-chain there is competition to capture the available profits. The interests of the pubco and the lessee cannot possibly “be aligned”.

Anyway, let’s go on:

“[Williams] pointed to pub industry closure statistics, suggesting they showed the greatest number of boarded-up sites across Britain’s ailing pub industry were free houses, not ‘tied’ premises.”

Ah, but there’s an explanation for this (well, several actually – the article notes that it is easier to replace a tenant landlord of a tied pub than a free-house landlord). My different point, though, is that, because the pubcos buy in bulk from a small number of brewers you’d expect them to be able to undercut free houses, except the big chains like Wetherspoons.* Damningly, though, Williams notes that:

“…the difference in bar prices between tied and non-tied pubs was very small — lager being about 8p, or 4%, dearer per pint in a tied house — suggesting competition was working well.

Astonishing.

And finally:

” ‘The market can deliver better than any state intervention,’ he said.”

My philosophy is that the state needs to intervene to manage markets. No-one’s talking about setting prices or anything. Yet another ridiculous statement from Simon Williams.

Until recently the state of British pubs was a long way from the top of my list of the world’s wrongs to be righted. But no sooner had I noticed that the legendary Tumbledown Dick is boarded up than I saw the Paper Moon in the same sad state.

We’re losing our history.

And a large part of the reason is because we apparently don’t properly understand competition.

—-
* Note: The buyer power of large organisations is a separate problem in the pub as well as supermarket and many other industries. I’ll discuss this another time.

Are we all Kevins now?

A while ago I started what was intended to be a series of posts detailing the causes of what I’m terming “The Great Crunch”.  I was planning to discuss the second cause today – but have decided forests merit my attention just now.  You’ve got to get your priorities right.

Nevertheless, as a bit of a trailer I feel I just have to draw attention to this Sky News story I just spotted on the handy syndicated financial news service provided by Yahoo!.  Yes, those nasty “Banks Face ‘Unfair’ Mortgage Legal Action” as Sky put it (and if their ambiguity was deliberate then I applaud it).

Well, we now all believe banks are intrinsically evil, of course, but let’s read a little further.  It turns out the noble David vs Goliath litigants took out somethings catchily called SAMS or “Shared Appreciation Mortgages” back in the ’90s.  And now the silly Sids are squealing because this time they’re not happy with how the deal worked out.  To be honest, I can’t even see why they’re upset, since they have apparently made money:

“The schemes, only available in 1997 and 1998 before being withdrawn from the market, allowed borrowers to take out loans secured against their homes, at a zero or reduced fixed rate of interest.

However, on repayment of the loans, they had to pay back an additional charge of up to 75% of the increase in the value of the property during the lifetime of the loan.

Their repayments ended up rocketing because of the sharp rise in house prices in the decade to 2007.”

The mortgagees, it seems, have been given free money (that’s what I term a zero interest loan), had the use of a property they presumably couldn’t otherwise afford for a decade or so, AND made a return of 25% of the increase in the value of the place.  Now they’re suing because, as Kevin would put it, “it’s so unfair” – presumably compared to the absurd windfall profits made by other homeowners or some other course of action they wished they’d taken back in the day.  “Aah, diddums”, I say.  From Sky’s story there seem to be no allegation of mis-selling.  The deal seems totally straightforward to me from a consumer point of view (and I’m not claiming special financial expertise here – I still don’t, for example, fully grasp why I would want to buy, for instance, “with profits” life and pension funds).

The point – which, as I say, I intend to develop further – is that – unless, of course, we want to experience never-ending financial crises – we have to somehow reach a state where individuals take responsibility for their own financial decisions.

It’s about weighing up individual interests against the general interest.  Once you strip away the bonuses, the Goodwinesque hubris, and the Byzantine financial complexity, banks are simply collective institutions for managing money.  Every dollar an individual takes from a bank undeservedly (or, indeed, deservedly) – whether as an unjustifiably (or, indeed, justifiably) massively inflated salary or bonus, through some court award against the bank, or, most significantly, through the writeoff of debt – must come from the other stakeholders in the bank.  Taking the banks as a whole, that includes all of us – especially as, at the end of the day, the taxpayer has to pick up the tab when the sucker goes down.

Screwed by Virgin

They say moving house is one of life’s more stressful experiences. It’d be a helluva lot less stressful if it was not for the numerous bureaucracies you have to deal with. Telecomms providers must be among the worst.

A final straw has been added and I have to let off steam.

My fun and games with Virgin Media started before I even moved in. I had the affrontery to attempt to close the account I’d had for 5 years at my previous address. I thought I’d take up an introductory offer when I moved. Maybe I’d remain faithful to Virgin, maybe not. I’d dared to think I might have a choice as to who delivered my bits and bytes. Well, as someone famously said, in a democracy you may be free once every 5 years when you cast your vote, but as a Virgin Media customer I discovered I was even less free than that.

My mistake was that I had changed the package I received 10 months before I moved. I’d been using phone, TV and internet, but wanted to restore the 24 hour news channels I’d given up some time before. I’d understood it was part of the Virgin offering that you could change your TV channels from time to time. Virgin’s twist is that they’ve invented various discounts. Even though the only change to the service was to add some channels and the bill increased by a few pounds each month, it seems I moved from “Ultimate Double 2″, to “Ultimate Triple”. Apparently, just because I’d moved from one bundle “offer” to another, this required a “new” 12 month contract. I have to take Virgin’s word that such a thing exists because I don’t have it on file. I found I was locked in to Virgin and had no real choice but to arrange to use Virgin at my new address. And guess what? I’m now locked-in for another 12 months.

It’s not something most consumers spend a lot of time thinking about but I’d be very surprised if the management of service-providers don’t employ a few MBAs to devise subtle ways to lock in their customers. A high degree of lock-in – that is, high switching costs for consumers – is actually in the interest of ALL incumbents in an industry. At the expense of consumers and new entrant providers. Think about it. Or just trust me, I’m an MBA!

Don’t get me wrong. It’s logical for a provider to require a period of commitment by the customer to cover up-front costs – think mobile phone contracts, or in this case the cost of sending an engineer to carry out the cable installation. But I hardly think a call to change the TV package constitutes a major up-front cost.

Theory would suggest that service will in general be poorer, the higher customers’ switching costs. I’ll leave the reader to judge whether such a conclusion is supported by my experience with Virgin. Here are a few of the straws that have been heaped on my back since I moved:

• Letters about my new contract were sent to the new address where an installation had been arranged in 2 or 3 weeks time, not the old one where I was actually living. One was returned to sender since other tenants didn’t recognise the name!

• Even more irritating was that the cardboard box Virgin sent for the return of my old set-top box – which lived at my old address, of course – was also sent to my new address. Duh. So, rather than post it back, I had to pack and transport Virgin’s set-top box. And take time as soon as I’d moved in to find where the Post Office keeps undelivered packages around here… – Still, on the plus side, Virgin’s engineer did turn up for the installation…

• …but left before the internet was working. He’d rung up, found there was a 20 minute delay before some gobbledegooky thing would happen (even though this appointment was made several weeks before) and gone to his next job. He did leave a mobile phone number, though. So when Virgin’s software asked me to ring up to “register the modem” (what does that mean?) yet their help-line couldn’t, um, help me, I rang him. He’d done his job, he said. Surreal. I went out for the rest of the day, rather unhappy, of course. When I came in, the modem had clearly managed to “register” itself and soon I was happily surfing away…

• …until last Thursday. No internet from around 5pm until sometime between 12 and 1pm on Friday. Call me a ninny, but I consider that a significant outage. My direct costs were £30.18 and my indirect costs £29.99. £30 because I’d received an email including a half-price offer for something I wanted to buy anyway. By the time I tried to buy, it was sold out. 18p because I’d been in the middle of registering a temporary Tesco club-card, which was still next to my PC when I was next in Tescos. £29.99 because I went out and bought a 3 mobile broadband USB device and £10 credit for next time this happens.

… …
I’ve tried getting compensation from Virgin before, and it’s not worth the effort. As I recollect, they will only pay from when you ring to report the problem – which you don’t bother to do when you hear the recorded message about the problems in your area – and only pro rata, i.e. they refund one day’s broadband charge per day of loss of service. This is pathetic. You’re paying for continuous, not patchy service. Consumers on their own are isolated and not in a position to change supplier behaviour. Government should represent the mass of consumers and impose sensible terms. In the case of broadband supply, outages of more than 12 hours should trigger automatic refund of an entire month’s charge; more than an hour or an hour cumulatively over a month would cost the supplier at least a couple of day’s charges. Of course, such outages would become very rare – this is called setting the right incentive. (Did Virgin work through the night last Thursday to resolve the problem affecting my service as quickly as possible? I somehow doubt it). If broadband internet is so important that we need a tax on landlines to subsidise its supply, then it’s important enough for companies to be compelled to provide a reliable service. And for customers to be compensated for something approaching the costs of non-performance by suppliers.
… …

• And we haven’t even reached the final straw yet. I’d opted (at my old address) for Virgin’s “eBill” service. This might be convenient if the bill was actually attached to an email. It’s rather irritating that you just receive an email telling you to log on to Virgin’s site to find your bill. Still, you pay £1.25 less (surely rather more than the bill costs to produce – we allow Virgin to create an incentive for us to do the right thing and save paper, whilst failing to give them sufficient incentive to provide a reliable service). OK, £1.25 won’t even buy a skinny latte these days, but it’s still an unnecessary expense. You’ve probably guessed by now that a few days ago I received a paper bill, complete with £1.25 “Paper Bill Charge” at my new address…

• Nope, there are more straws. Clearly I’d need to re-register for “eBilling”. But first, I thought I’d check my old bills. Doh! Of course, Virgin have given me a new account and deleted the old one (or at least made it inaccessible via my email address and the PIN provided). So the closing bill for my old account – only recently paid by Direct Debit – is inaccessible. How do I know I’ve paid the right amount? E-billing is all very well. It’s the future. It’s potentially efficient. But companies need to be compelled to keep data available. Again, government needs to step in and set some rules. I hate to say it but maybe it’s not really in suppliers interests to have consumers checking their old bills. Maybe when they’re not thinking about how to keep you locked in, some of those MBAs are working out how to keep you in the dark about charges…