Conclusion: A review of Gabelli Utility Trust’s (NYSE:GUT) three previous Rights Offerings (“Rights”) demonstrates on average such Rights offerings are at best a “wash” for shareholders while being beneficial for the advisor.
While on average a “push” for shareholders, the Rights offerings in aggregate increased advisory fees by $1.8 million annually and added $121 million of capital to “fund” GUT’s historically high return-of-capital (“ROC”) distribution which saps its NAV.
Valuation: GUT is currently trading at a statistically unsustainable premium of approximately 70% and it is supporting a high ROC distribution component through its managed distribution program. Additionally, there is limited historical evidence of a consistent positive return for those purchasing the shares in anticipation of a Rights Offering. Consequently, there is little support for the stock to move higher based on fundamentals.
Irrational Exuberance: While GUT may appear to be an overvalued security, Gabelli has a significant investment franchise and will likely continue to trade on the Gabelli “brand”. I would not initiate or add to an existing position at the current price and would consider selling a portion of an existing holding.
Previous Rights Offerings: On November 20th, 2009, GUT announced plans to explore the benefits of a Rights offering. Based on that announcement a review of its previous rights offering in 2002, 2003, and 2004 was undertaken to see how shareholders’ fared and the likely prospects of a future Rights offering.
Valuation Assumptions[i]: The results were based on the following assumptions:
1. A month preceding the Rights announcement, sufficient shares were purchased to qualify for a share subscription under the terms of the Rights offering; i.e., if you needed 3 shares for three rights to subscribe for one share you would have purchased 3 shares in the open market.
2. The share awarded under the Rights offering was purchased at the subscription price.
3. A month following the expiration date, all shares were sold. (In this example, a total of 4—the three purchased and the one subscribed.)
Historical Rights Offering Results: As it relates to the three previous Rights offerings, the table below illustrates that on average investors broke-even: 0.2%, (cell: “D10”). However, in two out of the three Rights offerings (2003 & 2004), shareholders would have generated a positive return. What dragged down the average was that in 2002 investors suffered a loss of 6.0%. This may have been a function of the pricing of the Rights—a subject to which we now turn.
2010 Rights Offering Projections: I am not aware of any formula GUT may use for arriving at the subscription price for its Rights offerings. However, here are a couple of data points to consider. Based on the historical averages, GUT’s subscription price was at a 22% discount from its stock market price and approximately 5.1% above its NAV. The stock was trading at an average premium of 35%.
Subscription Price: The key consideration for any current Rights offering is the fact that GUT’s current premium is 68% versus a historical average of 35%. This means there is more dollar value to carve up between the shareholders and GUT than in previous Rights offerings.
Simply put, the shareholders get the difference between the share price and the subscription price and GUT gets the difference between the subscription price and the NAV.
A Meaningful Difference: If the subscription price were to be calculated based on the discount of the previous month’s stock price it would be $6.92 per share (2010Est (A)). If the subscription price were to be calculated on the average subscription premium of 5.1% of NAV, it would be $5.55 per share (“2010Est (B)”).
In the former case, the shareholders’ return would be slightly better than break-even (“E10”), In the case of the latter scenario, shareholders would generate a positive return 4.9% (“F10”).
Err on the side of the Shareholders: As a consequence, the method of calculating the subscription value will determine whether the excess funds generated by the higher than historical premium flow to the shareholders or to GUT’s NAV. Given the fact that the premium is so high, shareholders should benefit from this temporal phenomenon.
Caveats: GUT’s Rights have been detachable and tradable so there was a market valuation of such Rights at the time of the offerings. However, such information is currently not available and would have been incrementally helpful.
My knowledge of Rights’ offerings and their mechanics is not complete. I employed what I believe to be a logical approach to a Rights valuation model. As a result, there may be one or several factors regarding the specifics of such an offering that could lead to a different conclusion. I’m sure others will contribute.
As always, consult your financial advisor prior to making an investment of this nature.
[i] The use of the previous month’s share price is a proxy for the cost basis of the shareholders. It is a reasonable assumption given the fact that NAV and share price remain narrow during the 2002-2004 period. Additionally, no transaction costs were imputed which would be consistent with an existing holding. Investors buying the stock a day after the announcement date and selling it a day after the expiration date would have lost on average 5.2% prior to transaction costs.
Disclosure: I do not own GUT