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What You Need To Know About Private Placements

Private placement is a method that listed companies or REITs use to raise more money. This is done through the sale of new shares or units to strategic individuals or institutional investors.

What does a private placement mean for minority shareholders? Will the enlarged stock base affect the company’s earnings per share in the future? To answer these questions, shareholders need to analyse a few aspects of the private placement and the underlying company’s business.

What is the purpose of the private placement?

Perhaps the first and most crucial question that investors need to ask is what the company or REIT is going to use the money from the private placement for.

There can be both positive and negative reasons that companies or REITs raise funds from private placements. One negative reason is when a company needs the money desperately to pay off short-term debt. This is obviously a concern and points to the company’s poor cash flow or poorly managed balance sheet.

On the flip side, a positive reason for a private placement is for an acquisition or expansion. For example, Frasers Logistics and Industrial Trust (SGX: BUOU) recently announced a round of private placement to raise funds for the acquisition of new properties in Europe. The acquisition will be beneficial to existing shareholders as long as the new assets generate more rental income and increase the REIT’s distributable income in the future.

Is the offer price reasonable?

In a private placement, investors are often given the opportunity to purchase the new shares or units at a discount to its current market price.

This is usually the case, as the offer price needs to be attractive enough for the investors to part with their money. However, at the same time, the offer price needs to be reasonable and not be too cheap which can dilute the interest of existing minority shareholders or unitholders.

Existing shareholders should do their research to find out if the private placement offer price is too low. One way to do so is to compare the offer price with the recent price of the stock or unit. Another useful metric to use is the price-to-book ratio. If the offer price is well below the book value (total value of assets minus liabilities), then the new units will certainly be a drag to book value per share and further dilute shareholder interest.

Is there self-dealing?

Finally, existing shareholders need to ensure that there is no self-dealing in the private placement. The strategic investors should be able to contribute positively to the company or REIT, and therefore, given a preferential offer for the discounted shares or units.

If the private placement is simply a means for institutional or in-the-know investors to get their hands on cheap shares or units of the company or REIT, then minority shareholders/unitholders need to be very wary and consider that management may not have the interest of minority shareholders at heart.

Unfortunately, it is very hard to assess if self-dealings are taking place. The only possible way for existing shareholders to find out is by looking at who the private placement investors are and how they can help the company or REIT. An unreasonably low offer price may also be a red flag and point to misconduct.

The Foolish bottom line

Raising funds through a private placement can be more effective and faster than a preferential offering to existing shareholders. However, it can also have the effect of diluting existing shareholders. Therefore, it is essential to look at the details of the private placement to see how it will affect the company and whether it really has the potential to benefit existing shareholders.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia owns units of Frasers Logistics and Industrial Trust.