Why Issue Subscription Receipts

Subscription receipts are often used as a form of acquisition financing in regards to equity.

A public company may need to issue equity when debt is either not available or is not prudent. For instance, if the indicative cost of debt becomes too high as the market feels that the company would have leverage that is too risky after the acquisition – or if the company feels the rating agencies would see this as a corporate action that may compromise their investment grade rating – issuing equity should be part of the funding plan.

However, many mergers are not successfully executed or closed – just like with any other business transaction. If a company were to have issued equity for the cash needed to fund the transaction and the deal fell apart, they would be stuck with cash that they did not need while having taken the price risk of issuing equity.

Subscription receipts will be converted into common shares upon consummation of the transaction. If the transaction does not close, sub receipt holders will get their money back.

If the reference stock pays a dividend, the subscription receipt will also pay a dividend.

From an investment perspective, sub receipts can be a good way to purchase stock in the company cheaply if an investor feels that there is a good chance the merger will be completed. Alternatively, it can also be a way to purchase the stock only if the merger is completed. Sub receipts tend to trade at a discount to the underlying shares, meaning a slightly better yield. For institutional investors, sub receipts are sometimes used as a merger arb vehicle.

Subscription Receipts in Investment Banking

The most important thing about sub receipts is that issuing them is within the investment bank’s equity distribution product suite.

Investment banks must consider them as a product when structuring potential mergers and acquisitions financing decisions and have a view as to where they would price. Engaging the equity capital markets team in an M&A transaction is a key way for the bank to get paid on the M&A advisory as well as the equity issuance (which is more lucrative from a percentage fee standpoint).

Investment banking analysts would have to run accretion/dilution for metrics that are important to the company adjusting for the new shares issued. After the deal, analysts would run the numbers for case studies that can be referred to going forward in advising new deals.

For investment banking analysts and associates not working on a live M&A deal involving subreceipts will still be well acquainted with the product owing to the importance of adjusting for them for comparables company analysis (or spreading the comps).

If an acquisition has been announced but not yet closed, analysts will have to add sub receipts to the adjusted number of shares outstanding in order to get to the enterprise value that reflects the pro-forma combined entity. Dividends will also have to be adjusted upwards. If analysts do not count the sub receipts, the value of the company will be understated and since forecast earnings and cash flow will reflect the combined entity, earnings and cash flow multiples will be off and therefore misleading.

Equity capital markets updates will also include sub receipts in their tracking for recent equity issues, acquisition-related equity issuances and for YTD or fiscal year statistics. As sub receipts are used as acquisition currency for existing public companies, they fall under secondary or follow-on offering buckets.

Example Subscription Receipts Issuance

Let’s say Company A wants to buy Company B for $15 billion and needs to issue $5 billion in equity. They are offering no stock consideration, so all shares of company B will be purchased for cash.

Company A announces a $5 billion bought deal (secondary) with a 10% greenshoe/option (investment bankers can sell up to 10% more if pricing is favorable) at $100 per share, representing a 5% discount to the last trade. Sub receipts offer the holder the right to convert to one common share of Company A upon transaction close.

Joint Bookrunners: Citi, JPM, Mizuho

Bookrunners are usually also the financial advisors for the M&A transaction or are banks that the company needs to allocate a larger share of the fee wallet to given what the bank does for them (lending money).