Forum Archive Index - May 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Gerry,

Apologies in advance for this long post which should have been posted 
a week or so ago.   My brain needed the time to mull it all over!

> 
> 
>I can add that in this case there were no "rights" but it was a
>placement @ 45 cents. The acute pre recording date price was 64
>cents and the ex issue price was 56 cents.
>
>

That being the case, the scenario is a little different to my cash 
issue example then.  Where there is a share placement there is no 
debt liability to the existing shareholders.  However, because the 
business (the pie) remains fundamentally unchanged, the existing 
shareholders will end up with a smaller share of what was the 
original pie.  I'll walk you through how I see the 'twin chart 
approach' to this problem.

Before the share placement was announced there were 82.7m AUO shares 
on the market.  According to Gerry the closing price on the day 
before the announcement was 64c.   The announced share placement was 
for first 12.4million shares then 37.6million shares (being a total 
50m shares) at a price of 45c.  I think we can assume that despite 
the second tranche requiring shareholder approval, the market 
regarded the approval of all shares to be issued as a 'fait 
accompli'.

So we can work out the theoretical ex issue price as follows:

(82.7m*64)+(50m*45)/(82.7m+50m)= 56.8c, or near enough to 56c

Right, at least Gerry, if no-one else, is with me so far!

Now, as I see it, the day the share placement was announced (26th 
February 2002) we effectively had two charts until the last of the 
new shares were allotted (23rd April 2002).  

Of course as 'on market investors' we only see one chart.   The 
second chart is only of interest to those lucky enough to be 
offered shares in the placement.  This first chart is the one that 
Phaedrus has been plotting for us.  But Phaedrus's chart represents 
(from 26th February) only 62 % ( 82.7m/(82.7m+50m)= 62% ) of the AUO
share capital.   Running parallel to this is the second chart, the 
chart of the new shares issued at 45c.  We shall assume that none of 
these new shares were dumped on the market for a quick profit in the 
up two months between when they might have been placed and when 
everything became one class of share again on 23rd April.

Now if we wanted to study the market sentiment as regards AUO on a 
monthly timescale, I would do it in three stages.

Stage 1: Before the placement was made (before 26th February)
Stage 2: When the market was aware of the share placement coming, but 
before the shares had all been placed (between 26th February and 23rd 
April) 
Stage 3: After all the shares have been issued (from 23rd 
April)

As I write this we are in 'stage 3', looking backwards.  So we'll 
start preparing our adjusted chart by looking at where we are now, 
then move further back into the past. 

------------
 
During stage 3, we simply take the closing price of the shares as 
our data point (as normal).

-------------

Now what happens to the historical data points we have archived from 
Stage 2?  At the start of stage 2 the market price for AUO shares 
fell.  If the new shares had been issued at 64c then there would have 
been no drop in the price of the existing shares on the market.  But:
 
1/because the new shares were going to be issued at a discount to the 
market price, 
2/ *and* the new shares were to rank equally with the existing 
shares, 

Then, this meant the average value of existing shares was 
diluted.  This is why we saw the fall in share price for the existing 
shares.  Stage 2 is easy to deal with.  Because all of the 
information regarding the share placement is available in the market, 
the market has adjusted the share price quoted on the market for us, 
to compensate.  All we need to do is take the end of day closing 
price as our data point (as normal).

------------

Lastly let's look at stage 1.  No speed reading.  From here on in.  
you are going to have to concentrate! 

Looking backwards from where we are today, the reason for the share 
price fall on Phaedrus's Chart 1 was because the share capital, which 
used to represent the whole company, no longer represents the whole 
company.  What happened was that the existing shareholders had their 
large pie reduced to a smaller one.  How?   Although the number of 
shares existing shareholders had did not change, the proportion of 
the underlying business that those shares represented went down.  

Specifically if we look at the figures:

Existing AUO shares: 82.7m
New Placement AUO shares:  50m

which means summing the two:

Total AUO shares after placement: 132.7m

This means that we need to scale back the share price closing levels 
in stage 1 to allow for the fact that these shares only represent:

82.7/132.7= 62% of the company.

If the new shares were to be issued at market price on the day 
of the placement announcement (64c), then we would need to multiply 
the closing value of the shares by 62% (that is 0.62)  to allow for 
the new shares being issued, and that would be that.   

However, because the new shares are being issued at 45c (a 
substantial discount) there is a one off transfer of wealth which 
occurs from the existing shareholders to the placement shareholders 
at the time the placement is announced.   We can work out what this 
wealth transfer is by using the 56.8c (theoretical ex issue price) 
per share calculated earlier.

Wealth transfer from existing shareholders
= 64 - 56.8 = 7.2c per existing share. 

Where does this wealth go?  It goes to the shareholders given shares 
in the placement.  But each of the placement shares has a wealth 
transfer of more than 8c to it, because there are less placement 
shares than original shares.

Wealth transfer to placement shareholders
= 7.2c x (82.7/50) = 11.9c per share

It is pertinant to remember here that 'before the placement was 
announced', the existing shares traded at 64c.  Also note the new 
shares were placed at 45c.

Pause here to reflect that:

64-7.2= 57c and 45+11.9= 57c

This shows that, after the share placement, the theoretical price for 
the existing shares is the same as the theoretical price for the new 
shares.  This provides a check that our working is correct because 
the new shares rank equally with the old, and so should have the same 
value.



--------



SUMMARY

We have two charts and because we are now in the present looking 
backwards we choose to adjust these historic charts retrospectively. 
This takes into account the fact that the new capital we have in the 
business now didn't exist at that time.  Now, how do we prepare both 
charts?

CHART 1 (Existing Shares)

>From the date that the new share placement is announced, plot the end 
of day closing figures as you find them (stages 2 and 3).   Before 
that time (stage 1), multiply each of the closing prices by 0.62, 
because these shares only represent 62% of the company as it is 
today.  The other 38% of the company as it is today is represented 
in stage 1 by the capital from the rights issue.  During the rights 
issue each new share was issued at 45c.  So 0.38 x 45c = 17c.   
Bringing it all together, the way you compile your 'chart 1' is to 
take into account the new capital of the company as follows:

Stage 1:   [(End of Day Closing Price) x 0.62 ] + 17
Stage 2:    (End of Day Closing Price)
Stage 3:    (End of Day Closing Price)

Example (Stage 1):   Closing price on February 26th (date the 
placement is announced) is 64c

So the value you put into your chart for that day is:

(64 x 0.62) + 17 = 57c

Observe that this figure is equal to the theoretical ex issue share 
price of 57c I calculated earlier.   This is not a co-incidence.  

If you go though and scale all your 'stage 1' chart figures, using 
the stage 1 formula I have given you, then you will find that the one 
off step drop in the graph between the day before the placement is 
announced and the day afterward, is eliminated.  This one off drop 
represented the transfer in wealth from existing shareholders to 
placement shareholders.  This drop was real (ask any shareholder who 
held those shares at the time)!   So doesn't this prove that the 
scaled adjustment of share  prices I have just postulated is a load 
of bollocks?

Well, no it doesn't (as I see things).   The secret to 
understanding this apparent paradox is to think about what happens 
if you buy AUO shares on the market today.   If you buy today, are 
you buying the new shares or the old shares?  It doesn't matter 
because as soon as the new shares were paid up there was no 
difference between the new and the old shares.  Effectively when 
you are buying shares today you are buying a  *mixture* of the new 
and old shares.   On 26th Febuary the existing shares spike down in 
value was exactly matched by the placement shares spike up in 
value.  Today, you are choosing to look backwards on the share 
placement event.   From your present point of view (because you 
are buying a mixture of old and new shares) those spikes in share 
value never happened!

If you plot things as I have suggested, you will eliminate that spike 
in the value of the shares which is mucking up your medium term trend 
lines, and was causing you all that grief Gerry!

CHART 2 (Placement Shares)

This chart only has two stages, as in stage 1 (out of three) before 
the placement was announced, these shares did not exist.  In stage 
2 (where this chart begins), the chart starts out at 45c (the price 
of the placement), but then it immediately jumps up by 12c to 57c 
(this is the one off transfer of wealth from existing shareholders).  
 Because these shares are untradeable until 22nd April, the graph 
then 'flatlines' at 57c all the way to the start of stage 3, 
whereupon the shares start trading.  The points on the chart in stage 
3 are then the end of day market prices of the shares as traded on 
the open market (same as Chart 1).   


>
> 
> This event would show up quite differenly on my manually prepared
> Chart -see my previous posts- than those produced at present.
>
>


Hopefully my 'Chart 1' as described in the summary, should pretty 
much tie in with your manually prepared chart Gerry.  



>
> 
> It does show fundamental investors need to read Charts together with
> the supplied data. Not to do so may lead to wrong conclusions and
> cost money: you could have been put off by a Chart of  what could be
> a splendid investment.
> 
> 


Agreed.  But you *can* adjust the raw chart to give a representative  
picture looking backwards.   When there is a share placement you 
can follow the methods that I have described.

SNOOPY



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