Post-Mortem On Reaves Utility Income Fund's Rights Offering

Sep. 6.12 | About: Reaves Utility (UTG)

Back in July I wrote about the Reaves Utility Income Fund's (NYSEMKT:UTG) rights offering in which it gave existing shareholders (or others who purchased the rights) the opportunity to buy up to 7.7 million new shares (about a 33% increase in common shares) at a price to be set at 95% of the lower of market price or NAV immediately before the exercise date.

As a longtime fan of the fund, I thought getting a 5% discount was a great opportunity, even though, as I also pointed out, there was a chance that the price advantage could evaporate during the period between when an investor paid in his/her money to exercise their rights and a week later when they actually received their shares. In other words, this was not a slam dunk arbitrage opportunity for traders, but it did seem - to me, at least - like a good bet for serious long-term holders. Many readers commented that I was being overly optimistic about the opportunity the rights issue presented, while some even said that the stock price would drop sufficiently, as a result of dilution and the supply/demand imbalance of so many additional shares dumped on the market, that the 5% discount would be wiped out completely. (As it turned out, they issued 5.9 million new shares, for an increase of 25%; less than the original plan, but still a sizeable expansion.)

Now the results are in, and, just like in our national politics, both sides can claim to be somewhat right, depending on how they interpret the data. In general, those who said I was overly optimistic turned out to be correct. On the other hand, I stand by my overall belief that the rights offering, with its 5% discount, turned out to be a good deal for long-term investors in UTG, albeit not as good a deal as I'd hoped for. Now that the dust has mostly settled, the shares are trading at a price (as of September 5) of $24.96, which is 55 cents above the subscription exercise price of $24.41.

That means any shareholder who exercised the rights they were issued has additional shares, paying the same dividend that they previously did prior to the rights offering, that are today worth 55 cents a share more than he/she paid for them. That's not the $1.27 discount that it would have been had the market price stayed firm during the subscription period, but 55 cents per share is still, well... 55 cents. Meanwhile the premium that the share price previously included, which averaged about 6.3% above NAV and got as high as 15.8% during the past year, has now flipped around to a discount of just over 2.4%. The yield, which had previously been below 6% for much of the year, is now slightly above 6%. So holders who like the stock, and want to continue re-investing in it, can now do so at a higher yield and without paying a premium. Plus they got to buy some additional stock at a discounted price, although not as impressive a discount as I anticipated when I wrote the article.

Anyone who went out and bought additional subscription rights on the open market (as I did) did not do as well. Although we didn't actually lose money, the cost of the rights (about 10 cents per right, and you needed three of them for each share you bought at the exercise price, or a total of 30 cents per share) reduced our gain (at the current price) to 25 cents per share. Again, as a long-time acquirer of Reaves Utility Income Fund, I am not personally unhappy that I bought additional shares at what now appears to be a 25-cent discount. But was it such a great opportunity, in retrospect, that it deserved a Seeking Alpha article? Perhaps not.

One thing the rights offering may have done was to increase overall investor interest in the stock. Prior to the announcement of the rights offering at the end of June, UTG shares seldom had a daily trading volume as high as 100,000, with 50,000-60,000 or even less being the norm. But in July and August, during the days leading up to the exercise date and the weeks following, 100,000 to 200,000 share days and even higher became relatively common. Much of the movement in the stock was downward during that period, as many rights exercisers probably disposed of the additional stock they acquired. But having bottomed at a closing price just slightly above the exercise price about a week ago (proving some comment writers correct who predicted that a patient investor - with excellent timing - would probably be able to wait and buy the stock without rights at close to the exercise price), UTG has risen steadily back to its current level (55 cents higher, or $24.96) while the volume has remained higher than its pre-subscription levels. Trying to "interpret" the meaning of price movements over a week or two in thinly traded markets is a foolish exercise, but if I were being interviewed on CNBC and had to come up with something, I'd say that the market for UTG "may have hit bottom as it digested the additional supply, and is now positioned for 'normal' trading at a slightly higher volume level, reflective of the higher market cap."

Personally I am glad to see the additional interest in UTG, if that means a bit higher trading volume and greater liquidity going forward. Readers of my other articles know that I like to maintain a stable of pre-selected and vetted closed end funds with roughly similar risk/reward and yield characteristics, and to then alternate among them as market forces (including the overall inefficiency of the closed end fund market generally) cause them to move from premium to discount and (hopefully) back again. So the greater investor interest in UTG, with accompanying higher volume and liquidity, should make it an even more attractive stock to buy, hold, and (occasionally) trade in and out of over the long-term.

Disclosure: I am long UTG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.