It’s not often that you’ll find a company ordering its shareholders to sell their stock. When that company has just had leading investment banks running round the globe flogging its shares to potential investors, the idea becomes even more bizarre. And when you see the disgruntled investors eagerly snapping up synthetic shares developed by the banks which had waved the original version in front of them, you begin to think there’s something seriously weird going on. Either that or someone’s got a great scam.
Strange as it may seem, this is a slightly askew rendition of what Qantas has been going through in the wake of its privatisation at the end of July.
The problem stems from a 49 per cent limit on foreign shareholders imposed by the government via the Qantas Sales Act. The government raised the previous 35 per cent limit on advice that there would need to be a more significant foreign element to ensure a successful sale. The foreign ownership regulations are written into the company’s articles and give the board the power to remove and retain the voting rights of any foreign investors holding shares in breach of the limit. It can then force them to sell their shares to domestic owners.
The danger of the foreign ownership ceiling being breached in the first few days of trading after the float was very real. British Airways already held a 25 per cent stake in Qantas which it bought in 1993. And the lead managers of the issue, SBC Warburg and Macintosh Securities, had created ample foreign interest in the deal during the book-building process.
Because of this high level of demand from overseas investors for a restricted part of the Qantas pie, the remaining foreign allocation was split. Aside from BA’s holding, there were 240 mn shares available for foreign buyers: 200 mn were allocated in the book-building, leaving 40 mn to soak up any excess demand from disappointed foreign investors in the first days of trading.
Before the float, Qantas warned the market of the possibility of the foreign limit being breached and announced that the company would police the ceiling by ordering foreign owners out of the stock on a last in-first out basis. After the allocation was reached, foreign investors still wanting to buy into the stock would have to alert the registrar of their desire to queue. The warning was repeated on the day of the float.
As it turned out, overseas investors soaked up the excess allocation and still wanted more. Matthew Playfair, associate director at SBC Warburg in Sydney, says that 36 mn of the 40 mn shares available were bought on Monday July 31, the first day of trading. By the Tuesday evening Qantas had made a statement to the Australian Stock Exchange saying that it had received foreign ownership notifications which put the foreign-owned stake at 51.42 per cent. The company confirmed that it would be unable to pinpoint the exact level of foreign ownership until August 18 due to the deferred settlement system. ‘Until that time, Qantas is unable to establish that the foreign shareholding levels are in breach of the 49 per cent limitation and whether the board will take consequent action under the Qantas Sale Act and the company’s articles.’
‘It was always anticipated that Qantas would be a large swallow for the Australian markets,’ says Playfair. ‘The sector’s not known about in Australia but there’s a great deal of knowledge in foreign markets and there was huge demand generated in excess of that available.’ Playfair points out that Qantas had been open with the market about the situation throughout the build-up to the float and after trading commenced. He believes that the rapid move to a foreign holding overhang was due to ‘a number of brokers who failed to read the screens’ or did not comprehend the registrar’s time-stamping system for foreign orders. ‘Once the level had been hit a lot of people were screaming that it was a stuff-up by Qantas or a stuff-up by the government,’ says Playfair. ‘In fact a lot of institutions were misled by over-zealous brokers. I’m hard-pressed to find any fault on the part of Qantas.’
Despite criticisms of the way the Australian government and Qantas had handled the foreign ownership question, they had really done nothing remotely out of the ordinary. Airlines have to be majority controlled by domestic shareholders to allow negotiations between governments for bilateral treaties on routes and operations. Other airlines, including Air New Zealand, have resorted to split A and B share structures, with different voting rights, as a means of getting round the problem. The government and Qantas had rejected the split structure option before privatisation, however, on the premise that it often leads to the foreign ‘B’ shares trading at a premium to the domestic ‘A’ shares.
‘There are really two problems,’ explains Gary Pemberton, chairman of Qantas. ‘One is that if you had two classes of shares in a float this size, it would have significantly reduced liquidity for the domestic institutions. Second, it would have clearly established a two level price structure. Conversely, we have the advantage that the price of Qantas shares to Australian shareholders is reflecting the pressure of the overseas demand, and Australian shareholders are getting that benefit. The price we pay is the administrative complexities of continuing that situation.’
Pemberton could also have mentioned the growing objections of many institutions to holding stock in which they have limited or no voting rights. The foreign ownership ceiling may prevent some from getting into a stock they favour, but those overseas investors with holdings at least know that when problems occur they have voting muscle on their side.
But there is a price to pay with the single share structure in such a situation. Qantas’s stock price fell 2.8 per cent in the week after it revealed the breach of the foreign shareholding limit. And, despite the best communications efforts from the company to reassure the market, that uncertainty still hangs over the stock.
As early as August 4, Pemberton acknowledged that the situation was not entirely satisfactory for foreign investors as they could not be sure of their net positions until the register had stabilised. At the same time, in a bid to rectify some of the uncertainty, the company announced that the Qantas Share Registry would offer a telephone advisory service to give information to foreign shareholders on their level of priority for entry into the foreign sub-register.
Another cost is that some big-time investors were put off the deal altogether. ‘It’s an annoying situation because at the issue price we found it attractive,’ says one fund manager at a leading London-based institution which balked at the Qantas offer. ‘Unfortunately an investor of our size can’t risk investing our clients’ money in such an uncertain situation. It’s a pity another structure with another class of shares wasn’t set up prior to the offer.’
The question of splitting the share structure in the aftermath of the float and a ‘settling down’ period has continued to arise in the Australian media. Although careful not to rule out any option, Pemberton has been adamant that suggesting to the markets that the company is considering a split structure as a way out of the problem would be investor relations suicide. ‘We’re not closed minded about it and we’ll continually review it,’ says Pemberton. ‘But there’s no way that we will do anything quickly. Nor, if we were to act, is there any way we would not impose a very long lead time so that the market would know exactly what was happening and where it was going.’
As soon as the unmet demands for Qantas stock became apparent, derivatives whizz-kids at a number of investment banks attempted to come to the rescue, unable to bear the idea that there might be unsatisfied buyers kicking around. Several banks have developed alternative investment instruments which give international investors exposure to the Qantas risk and reward profile without actually buying into the stock. SBC Warburg, Macquarie Bank, Bankers Trust and County NatWest have all got into the synthetic Qantas share market with performance-linked equity securities, called warrants and QanMacs. More are expected to follow if the derivatives perform well.
Perhaps the most widely marketed of these instruments has been the QanMac as developed by Macquarie Bank and traded on the Australian Stock Exchange. QanMacs are essentially debt securities issued by Macquarie with a five year extendable life which emulate Qantas shares. Macquarie has undertaken to make a market in the derivatives by bidding for 500,000 QanMacs each day at 99 per cent of the underlying price. And it has guaranteed that it will repurchase at least 10 mn bi-annually when Qantas announces its dividend to satisfy any unhappy customers. QanMacs have been trading at a premium to the underlying shares – in a similar fashion to many of the B shares in a split share structure – possibly caused by a more favourable withholding tax liability than the long-term share dividends. Macquarie has been buying Qantas shares to hedge its position.
‘The main problem to overcome was to not give any foreign interest in the Qantas shares,’ says Ottmar Weiss, executive director in charge of equity structured products at Macquarie in Sydney. ‘We’ve taken a debt instrument and given it a pay-off profile of yield and capital performance that mirrors Qantas’s shares. We wanted to come up with something like the Qantas share aside from on the voting issue. I think we’ve done that.’
Not according to our disgruntled London-based fund manager, however, who is not tempted by any of the derivatives being offered to date. ‘No offence to those involved in their development,’ he says. ‘But I’m always a bit cynical of synthetic instruments because of the liquidity problem. It’s very easy to get your fingers burnt. Obviously, they don’t give you any voting rights either, which could be a problem for some clients.’
The derivative route might not be right for some but it has provided a handy alternative for others and Macquarie reports brisk trading in the first week its QanMacs were listed. In many ways that’s good news for Qantas, although it has been careful not to endorse any of the synthetic shares on offer. On the contrary, there have been reports that the company is investigating to see if any of them breach regulations.
Despite such scepticism, Leon de Bord, manager of corporate communications for Qantas in Sydney, points out that Macquarie has been buying Qantas shares to cover its positions. So any effect from foreign investors turning to QanMacs because they have received notice to withdraw from the stock is likely to be largely nullified, which is good news for the company and the other Australian investors. The foreign banks with synthetic products on offer must also set up hedging arrangements which somewhere down the line would probably mean buying Qantas shares through an Australian party.
Qantas also benefited from entering the index in the same week as QanMacs were listed. Although it’s difficult to judge the trade-off in the absence of hard figures, many of the enforced foreign investment withdrawals were clearly replaced by local index funds which became bound to buy the stock.
Meanwhile, the company continues to police its register according to the 49 per cent level and has issued notices to those foreign shareholders whose purchases resulted in a breach of the limit. In normal cases the company will give the shareholders 30 days to dispose of the offending holdings. But it has announced that due to the extenuating circumstances immediately after the float – the rush to mop up the remaining 4 per cent of the foreign allocation – those that bought before August 15 will have 90 days to dispose of the relevant holdings. Since the initial flurry of activity the clamour from foreign buyers has calmed down and the company does not expect to have to issue as many notices in the future.
Pemberton and other executives have continued to dismiss the foreign shareholder overhang as being of manageable size ever since the first figures were available on August 18. ‘A 22m share overhang in a company the size of Qantas, given our daily turnover, is a manageable situation,’ said Pemberton at a press conference on August 24. ‘I think the market is clearly reflecting that perception. The critical issue is that I will carry the voting rights of any of those shares involved in the overhang. So the speculation about Qantas being foreign-owned is completely unfounded.’
