Reaves Utility Income Fund: What Do The 2012 And 2015 Rights Offerings Tell Us?

| About: Reaves Utility (UTG)

Summary

This is a third, and final, analysis of the UTG rights offering.

Here, I review the 2012 and 2015 events.

Attention is on discount, Z-scores and prices.

At this stage in the process, market responses to the current offering resemble the events that had occurred previously.

I have been writing about the current rights offering for Reaves Utility Income Fund (UTG), a closed-end fund (here and here). To summarize briefly, UTG is expanding the fund's assets by having issued transferable rights to all shareholders of record on Aug 29, 2017. Shareholders of record received one right for every share owned. Each three rights entitle the holder to purchase one share of UTG at 95% of the average market closing price for the five days through the Oct 4, 2017 expiration or 95% of the NAV on the expiration date, whichever is lower. This is the third such expansion of the fund since 2012.

The articles have generated extensive discussion. In the second one I noted some of the price history on key dates for the previous rights offerings (2012 and 2015). Readers have expressed interesting in knowing more on the premium/discount details for the fund for the period surrounding the rights offerings. Someone requested historical Z-scores. As I have the data to generate the Z-scores, it was fairly straightforward to run it up.

Historical Z-Scores

I have, therefore, put together an analysis of Z-scores and discounts for the fund beginning a year before the 2012 rights offering through 14 Sept 2017. In the next charts I show Z-Scores for 3-, 6- and 12-months.

For more clarity, I show them as 3-month rolling averages for the Z-Scores.

It's clear from these charts that discounts moved sharply down as the rights offerings progressed through the stages from first announcements through expiration.

Discounts and Premiums

To underscore the point, here is a chart of Premium/Discount status over the same time scale.

Discount at Rights Exercise

The key point to remember, however, is that rights holders exercise their rights at an additional -5% discount. To illustrate the point, I've noted the discount at the exercise price for 2012 and 2015 plus the actual discounts when the rights expired and one week later in the next table.

Exercise Date

Exercise Price

NAV

Exercise

Discount

Actual Discount

8/10/2012

24.08

26.17

-7.99%

-3.40%

8/17/2012

-4.39%

12/11/2015

23.99

27.87

-13.92%

-12.27%

12/18/2015

-8.41%

For both years exercising the rights gave a substantial discount to the prevailing discount on the open market. In 2015, the market discount was transiently low. It's hard to know why, but there was a sharp decline in market price (-8.6%) over the five-day averaging period used to determine the rights' exercise price. For the previous ten days market price had approximately followed NAV. The decline relative to NAV over those five days generated a meaningfully lower price and a meaningfully deeper discount for the exercised rights.

The next chart shows market price for UTG for two weeks on either side of the rights expiration date. The shaded region is the five-day averaging period for the determination of the pricing for the rights exercise. The arrow indicates the expiration date.

Summary Points

The information here shows that for the two previous rights offerings, shareholders who exercised their rights received new shares at a substantial discount to market price. This was especially the case in 2015 where the market price declined sharply during the five-day averaging period. Post-expiration recovery of the decline in market price that preceded the expiration date was slow and, as we saw in the previous articles, did not come back to levels of prior to the rights offering for several months. Discounts remained much below pre-expansion levels in both years. In general, the rights offerings adversely impacted existing holdings over the short term. I've not tried to sort out the extent to which exercising the rights at the additional -5% may have compensated for those losses. One thing that is clear, however, is that the offering was a negative event for those holding UTG but did not exercise their rights.

In the discussions in the previous article some commenters suggested the best way to play this event would be to sell the shares one is holding and exercise the rights. But for this strategy to work best, one would have to have sold the shares prior to the ex-rights date, at the time of the first preliminary announcement. In that case, one would not have received the rights. Rights are transferable, so they could have been purchased on the open market. So a strategy of selling at the announcement, buying rights, and purchasing replacement shares at the -5% additional discount would have worked to sharply reduce one's basis in UTG when the entire cycle played out. But, for the current offering, that window is closed and share price decline has taken a toll. There may still be gains to be had in selling now and replacing one's position with shares purchased using the assigned rights and, perhaps, additional purchased rights. That strategy would have played out for a small gain in 2015, but there is no guarantee this year will look like 2015.

As I've noted earlier I do intend to exercise my rights. I've also purchased additional rights which I will exercise as well. UTG is, in my view, among the very best opportunities for utilities sector allocation. When I opened my position, it was with the intention of increasing the size of that position as buying opportunities arose. I consider this rights offering as the buying opportunity I had in mind.

Finally, for anyone distressed by the apparent loss of shareholder value the rights offering may entail in the short term, I'd refer you to this article: The Top Utilities And Infrastructure CEFs. As you'll see there, UTG has led the field for total return even with the transient declines resulting from the 2012 and 2015 rights offerings.

Disclosure: I am/we are long utf, 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.

Additional disclosure: I am not an investment professional and nothing I write here should be taken as professional advice. Readers should realize that my writings and thoughts here are my research notebook. Everyone's personal situation is unique. It is the role of finance professionals to provide advice in the contexts of an individual's personal situation. What may be right for my investment goals and risk tolerances may well be quite wrong for someone else. Do your own due diligence or consult with professionals on your own needs, objectives and tax circumstances before you invest.

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