Oops ! Michelin decides to launch a rights issue

On Tuesday Sept 28 2010, Michelin announced a surprise capital increase of € 1.2 bn … and the stock price immediately dropped by 10%, wiping out about the same amount from the pre-money market capitalization! What’s going on here?

At first sight, such market reaction seems absurd.  The company is recovering nicely from the crisis and the stated use of the proceeds is investment in emerging countries where Michelin has not enough production capacity to fulfil the expected market demand.  Doesn’t that sound like a juicy positive NPV business case to you?

The explanation is bad communication, in other words surprising the market.  It is Michelin’s first cash call in 30 years, so this move is certainly a bit exceptional.  And, back in June, the CEO had sounded very cautious on growth and new investment.  So, investors are justified at wondering: why that sudden change? Are they under pressure from their banks to increase the equity? Are they planning a (potentially value destructive) hostile take-over bid?  The CEO’s explanation were not concrete enough to dispel the doubts that future profits will not be high (or secure) enough to compensate for the extra number of shares.

This effect is different from a technical adjustment that happened two days later when the rights to participate in the capital increase were split from the shares.  It’s an issue of 2-for-11 (2 new shares for every 11 existing shares) at a 27% discount to the pre-announcement stock price, i.e. at € 45 per share vs € 63.1 per share.  After the announcement, the price had dropped to € 55.7. Obviously the right to subscribe at € 45 a share priced at € 55.7 is worth something.  How much? If you buy 11 old shares at € 55.7 and then subscribe to 2 new shares at € 45, you will have spent € 702.7 for 13 shares or € 54.05 per share.  That will be the ex-right price of a Michelin share.  A single right is then worth € 1.65 (i.e € 55.7 minus € 54.05).  And indeed if you buy 11/2 rights at € 1.65 to subscribe a new share at € 45, you will have spent € 54.05 per share. Or if you buy an old share at € 55.7 and sell the right at € 1.65, you will have also spent € 54.05 per share. Q.E.D.

More comments on the operation at:

http://www.lesechos.fr/entreprises-secteurs/auto-transport/actu/020822460113.htm and http://www.ft.com/cms/s/0/ecd69b60-cacb-11df-bf36-00144feab49a.html

and the prospectus at http://corp.michelin.com/augmentation-capital/documents.php

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