Listed firms turn to debt financing to raise capital

Listed firms on the Nairobi Securities Exchange are loading more debt onto their books as they seek fresh capital to finance operations and implement ambitious development programmes.

Regional beer maker East African Breweries Ltd (EABL) and investment firm Centum Ltd have laid the groundwork to tap into millions of dollars in the debt market.

The decision on whether debt or equity financing is the way to go has mostly remained the preserve of the boards of these companies. But analysts now say debts can be more prized by shareholders if the proceeds are well-spent and if the market rates are favourable.

“The impact of taking up more debt is that it increases the risk to the company but more importantly the returns to the shareholders increase at the same time,” said Paul Mwai, chief executive at AIB Capital Ltd.

“As people borrow cheaply and repay their loans, the returns to shareholders in the long term are better. What this means is that if you are able to use cheaper debt to finance your operations then the shareholder wealth in the long run will be higher.”

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Equity financing is money lent in exchange for ownership in a company while debt financing refers to any borrowed money which the company must pay back to the lending institution. It can be in the form of a bond, loan or line of credit.

According to Johnson Nderi, a corporate finance manager at ABC Capital, debt financing through the capital markets is becoming more and more common because of the unpredictability of commercial bank rates and the high rate of return on equity financing.

"Shareholders have no problem investing in a company that is performing well. Debt appears to be more favourable," said Mr Nderi.

Usually, firms have two options when it comes to raising additional capital without taking out a bank loan. They can either issue corporate bonds or sell company shares without taking the company to the public.

It is however argued that issuing bonds or shares affects the corporation in different ways. With a bond issue, you have the benefit of reducing your tax liability without sacrificing control of your corporation.

Bondholders are creditors to the firm but not the owners. Each share represents a potential ownership claim in the firm and every share sold further dilutes ownership percentage.

According to Mr Nderi, debt always enhances the return to investors if the business is able to repay the debt.

“What we are seeing is a process of intermediation as bank financing becomes less and less relevant compared with financing from the capital markets,” he said.

According to Eric Musau, a senior research analyst at Standard Investment Bank, the process of raising additional funds through rights issues is longer compared with the debt market.

“Going for a debt increases your returns to shareholders. Debt is something one can employ to improve the return on equity,” he said.

EABL is seeking to raise $121 million through a commercial paper. The proceeds of the medium term notes, according to the company’s information memorandum, will be used for capital expenditure ($56 million) and working capital investment and general commercial purposes ($65 million).

Centum Investments Ltd is said to be contemplating a related move to fund its ambitious projects in the real estate sector. Other firms that have already issued medium-term notes include mortgage lender Housing Finance Ltd ($220 million) which was approved by CMA in November 2013, and Shelter Afrique ($88 million) for habitat and housing in Africa, approved in August 2013.

The East African Development Bank proposed the establishment of a regional multicurrency medium-term note programme. The Note whose minimum size to be issued stands at $850,000 was approved by CMA on September 2013.

Troubled sugar miller Mumias Sugar Company which is on the verge of collapse due to corruption and mismanagement, intends to raise $33 million from its disgruntled shareholders. The funds will be used for the restructuring of the company.

“If Centum Ltd invests wisely in the project they are implementing, then that will improve the shareholder value. On the other hand, if EABL plans to replace expensive debt with cheaper debt then we expect to see interest costs come down and this will translate into improved earnings at the end of the year,” said Mr Mwai.

According to the information memorandum, EABL notes will be available to the general public in Kenya and the price/yield, tenor, amount and allocation of notes to be issued under this programme will be determined by the issuer, the arrangers and placing agents at the time of issue in accordance with the prevailing market conditions as set out in the relevant pricing supplement.

EABL is listed on the NSE and is cross-listed on the Dar es Salaam Stock Exchange and the Uganda Securities Exchange.

Last year, a number of Kenyan banks including Diamond Trust Bank (DTB) and NIC rushed to raise additional capital from the shareholders through rights issue in a bid to comply with Central bank’s new capital requirements. DTB and NIC Bank raised $40 million and $23 million respectively from their shareholders.

Uchumi Supermarkets raised $10 million in additional capital through a rights issue during the same period.

Data from Kenya’s Capital Markets Authority shows that a total of $988 million was raised through rights issues by firms listed on the NSE between 2004 and 2014.

The global standard setting bodies, the Basel Committee for Banking Supervision and Financial Stability Board, introduced capital buffers (additional capital above the minimum regulatory capital ratios set by regulators) after the 2007-2009 financial crisis to help commercial banks withstand adverse economic shocks.