Rolls-Royce's rights issue is emergency button it should have pressed sooner

Nils Pratley
·4-min read
<span>Photograph: Justin Tallis/AFP/Getty Images</span>
Photograph: Justin Tallis/AFP/Getty Images

The process was slow and spluttering, but Rolls-Royce got there in the end: there will be a fully underwritten rights issue to raise £2bn, plus a new £3bn debt package. If the civil aviation market comes out of hibernation by 2022, it should be enough.

The UK’s premier engineering company didn’t even have to trot off to Singapore for sovereign wealth money. It appears that current shareholders said that, if new shares are to be printed at desperation prices, they’ll take them.

And the UK government, via the export finance scheme, will play its part by slapping a 80% guarantee on £1bn of Rolls debt for five years provided shareholders cough up their bit; that’s on top of the £2bn that already carries a state-backed label.

One could call the package a homegrown solution – and it’s better for it. Chancellor Rishi Sunak has held his line that companies must try self-help measures first, but the Treasury has oiled the wheels by playing nicely on the debt side. That’s a pragmatic fudge.

One can’t say definitively that Rolls is saved because that’s an impossible punt on infection rates, travel restrictions and vaccine development. But, on what Rolls calls its “base case”, the engine-maker has comfortable financial clearance.

That projection sees the group generating £750m of cash in 2022, partly as the gains from heavy cost-cutting and redundancies arrive. In the meantime, Rolls intends to bolster cash resources with £2bn-worth of disposals. That would provide ample liquidity.

It was the “reasonable worst case” analysis that was scaring investors, however. Armed with fresh funds, Rolls is now confident its liquidity would now survive intact even if engine flying hours – the critical driver of revenues from servicing those engines – are just 45% of 2019’s levels next year and recover only to 80% in 2022.

Investors can still fret about an (un-modelled) unreasonably severe case. But, assuming the financial package is completed, horror scenarios of collapse or full-blown state bailout should be off the table for a while. There will be some medium-term solidity in Rolls’ balance sheet.

None of which can disguise the calamity in a share price was 735p this time last year and is now 117p. Even though half of Rolls’ business is in the safe territory of defence and power systemic, the pandemic’s damage to engine side has been extreme. A £2bn rights issue is the emergency button. In retrospect, the board should have pressed it a couple of months ago.

Reform of underwriting always seems next corner away

Naturally, banks stand to make a packet from Rolls’ rights issue. Underwriting and advisory fees will total £55m, which, even when cut several ways and with a chunk going to subunderwriters, will keep a few investment bankers in bonuses this Christmas.

The banks will justify a rate of 2.75% on a couple of grounds. First, the recent Hammerson and IAG fundraising gave underwriters some sweaty moments as both companies’ share prices came close to the rights prices; for a change, the risk of being left with unwanted stock was real. Second, Rolls’ underwriters are on the hook during the US presidential election, potentially a market-moving event.

There’s force to both points. Yet note how, when rights issue are launched in times of clear skies and minimal market risk, one never hears the reverse argument for cut-price underwriting fees. Reform of a cosy set-up always seems to remain around the next corner.

Supermarket customers don’t mind but shareholders do

Ken Murphy arrives as chief executive of Tesco with advice flying at him from all sides. Sell Tesco Bank, say some, it’s a capital-hungry distraction. Or complete the international retrenchment job by getting rid of stores in the Czech Republic, Hungary and Slovakia. Or whack up the dividend and settle for being a reliable income stock.

Yet the biggest challenge seems obvious: how to make decent returns from online deliveries. The only near-certainties during Murphy’s time at the top of Tesco is that the online slice of the grocery market will increase in the UK and that Amazon, which has fiddled for years but now seems serious about expansion, will want a bigger helping.

All the supermarkets have added online capacity at impressive speed during the pandemic, not least Tesco. But their share prices are lowly rated, in part, because the growth looks low-margin at best. Customers don’t mind, obviously, but the shareholders do. It’s the pressing problem for a new boss.