Take, for instance, Golub Capital. In the decade that Golub Capital has been public, its stock has traded in a very narrow band of between $15 and $20 per share. That is until the third week of February, when the growing impact of the spreading coronavirus began to hit and the hidden risks on the balance sheets of LBO portfolio companies began to register with investors. Between February 21 and April 1, Golub Capital’s stock fell 50%. On April 1, the company announced that it was raising new equity capital, to shore up its balance sheet, through what is known as a “rights offering”—stock that is offered only to existing shareholders, often at a discount to the current trading price. The idea behind a rights offering is that existing shareholders, who already own stock in the company, are more likely to buy more stock in it as long as the stock being offered is sold at an attractive price, often below where the stock has been trading.
For shareholders, rights offerings have a whiff of an offer they can’t refuse. On the one hand, they are often terribly dilutive to the value of the shares they already hold—a lot more stock issued at a lower price than the current market price. But they also offer these shareholders a chance to protect the value of their investment by buying more stock at the lower price. Shareholders get to choose: get in deeper or lose more. They’re also, if not a sign of desperation, something of a last resort. They signal to the market that a company has few other viable choices for raising new equity but to tap its existing shareholders in a coercive way. That’s a red warning light for many investors and a clear indication of the trouble brewing for the portfolios of many private-equity firms and for the shadow banks that financed the buyouts.
In its report on the Golub Capital rights offering, Keefe, Bruyette & Woods, a highly respected investment bank focused on the financial sector, wrote that it was “surprised” by the Golub rights offering, which was equal to 25% of its outstanding shares. “This was surprising to us given their solid balance sheet and the timing is very early in the cycle,” the bank wrote. “If a top-tier manager is willing to do a dilutive rights offering, we believe this could potentially spark a wave of offerings as other [similar companies] look to follow their footsteps.” KBW wrote that it had considered Golub’s balance sheet to be “in pretty good shape” at the end of 2019 and one of the best managed of the shadow banks. “Which leaves us surprised, concerned, and a little confused,” it continued. “Generally, we view dilutive equity offerings as a sign of weakness but given the unprecedented economic uncertainty, this could ultimately be the correct decision longer term, depending on how the ‘sudden-stop’ economic downturn plays out.” Since the offering, which raised $3 billion of capital at $9.17 per share across five of Golub Capital’s funds, Golub’s stock has traded up about 20%, to around $11 per share but still well below where it was trading in February. It has a market capitalization of around $1.5 billion.
As KFW surmised correctly, other shadow banks also initiated rights offerings. In a March 30 letter to its shareholders, Bain Capital Specialty Finance, an affiliate of Bain Capital, the big private-equity firm once run by Mitt Romney, announced it, too, was doing a rights offering. Like Golub Capital, the Bain affiliate does a lot of business with private-equity firms. In fact, 95% of its loans come from private-equity deals involving 114 companies across 30 industries, with most of the loans in the technology, aerospace and defense, and health care and pharmaceutical industries.