EROAD: Markets don’t like surprises

EROAD has been a roller coaster ride for investors over the last couple of years. From a share price high close to $5.70 in July 2021 and the purchase of Coretex that same month, it’s been a fair degree of one-way traffic since then. The departure of founder Steve Newman as CEO in April 2022 came as a surprise to the market; the share price declined by close to 20% within a week (from $3.70 to around $3.00). By May 2023, the shares were trading at around $0.45, impacted by both macro-environment and company-specific factors.

For EROAD, the costs of hardware replacement and the longer runway associated with the Coretex integration were weighing on investor sentiment – it was a “period of transition” as the company itself acknowledged in its results announcement in November 2022. At a macro level, rising interest rates and a desire for positive cashflow in tough times had focused market sentiment away from the entire technology sector. In March 2023, EROAD announced it was undertaking a strategic review, led by Goldman Sachs and also noted a target to be free cashflow (FCF) neutral by FY25 and positive by FY26 through a combination of cost initiatives and capital reduction following the rollout of new customer hardware.

At that share price, it shouldn’t have been a surprise that in June this year, EROAD received a non-binding indicative offer of $1.30 per share from (ultimately) Canadian-based Constellation Software. Due diligence was firmly rejected by the Board on July 12th. NZSA took an alternative view to many market commentators, noting an opportunity for a partial takeover or cornerstone shareholder injecting capital into the business – but retaining existing shareholders within the business.

That position recognised a degree of investor sentiment that EROAD was likely to require further capital, although that wasn’t directly addressed by the company itself. Indeed, at the company’s shareholder meeting on July 28th, in response to a question on the likelihood of a capital raise from none other than Steve Newman – who remains a large shareholder – the response was that “the company had sufficient capacity to hit targets“.

A carefully worded response indeed. Having the capacity to achieve its critical FCF-neutral target is one thing – but of course, the probability of being able to do increases greatly if there’s some extra cash in the kitty to resolve that pesky hardware 3G –> 4G upgrade more quickly.

Capital raise and discounts

On September 7th, the company announced a capital raise of $50m, comprising an institutional placement of $11.6m and a renounceable, entitlement offer of $38.4m.

EROAD states that the purpose of the offer is to “provide funding flexibility, strengthen the balance sheet and allow EROAD to accelerate its North America growth strategy“. That’s apparently based off feedback from shareholders and potential investors that reducing debt levels would be seen as positive in the current environment.

On that basis, even if the debt will be repaid a year early, it’s hard to disagree with the logic of the raise.

Where eyebrows start to be raised however, is the level of discount compared with the (prior) share price. The share price following the Board’s rejection of the non-binding indicative offer from Constellation has been trading in a range between $1.35 – $1.39, being a significant premium to the $0.75 – $0.80 that preceded the offer. There was a certain confidence in the Board (and shareholders) that EROAD’s strategy was back on track.

Now, here is EROAD raising capital at a mere $0.70 – a 49% discount to the share price preceding the raise. Even if one understands the logic of the capital raise as strengthening the balance sheet by reducing debt, that seems like a very expensive way (for shareholders) to reduce debt. A 49% discount implies a recapitalisation more associated with a distressed company, rather than one confident of achieving its strategic outcomes.

As an aside, it would appear that the company’s choice of method for raising capital has improved, at least from the perspective of small shareholders. Back in 2021, the purchase of Coretex was funded by an institutional placement of $64m, with a much smaller allocation of $16.6m set aside for retail shareholders under a Share Purchase Plan. The current offer comprises a total of $50m, of which only $11.6m is by way of an institutional placement with the remainder being a fully-underwritten renounceable entitlement offer. For those who don’t (or can’t) participate, an institutional bookbuild of non-utilised rights may see some value returned.

All very fine in theory. In practice, however, it’s by no means certain that any shortfall will be cleared at a premium for non-participants.

On the face of it, it would seem that EROAD’s decision to set the entitlement price at $0.70 was the right one when it comes to ‘what the market will bear’. The institutional placement that was undertaken last week had to cover a shortfall, from the non-participation of both Constellation and Steve Newman. There was no premium on offer however – while the placement shortfall was fully subscribed, it cleared at the offer price of $0.70. There is an alternate view that proffers a more ‘reflexive’ reality – has the company caused a re-rating of itself by its very action of pricing the entitlement shares at $0.70?

The non-participation of both Constellation and Steve Newman must be of concern to the company – the offer outcomes will result in significant dilution of their shareholding, so is not a step taken lightly. Particularly in the case of Constellation, that may indicate a belief that they will be able to purchase shares on-market at a lower rate at some point in future. Or they are not willing to put more good money after bad. In either case, shareholders will be hoping this is not the case.

For a non-participating shareholder, the combination of the steep discount, the dilutionary effect of the institutional placement and the likely lack of premium that will be achieved over and above the $0.70 entitlement offer price creates a ‘triple whammy’ effect that incentivises participation, whether via the offer or on-market (the shares are currently trading at the offer price).

It will be interesting to see how the retail entitlement offer progresses (this closes on September 22nd). The offer is fully underwritten, so EROAD will get its capital regardless – but there is the possibility that a low level of participation will create an ‘overhang’ on the share price for some time. The company appears to be contacting shareholders by phone to ‘inform’ them of the offer. An unusual practice in a New Zealand context – but one that perhaps highlights the degree of concern held by EROAD’s Board in relation to shareholder participation.

Retail Investor Conference Call

EROAD CEO, Mark Heine, and Chair, Susan Paterson, hosted a call for retail investors last week. Regardless of the questions surrounding the capital raise, NZSA thinks this is a great initiative; it’s good to see a commitment to inform retail shareholders in a similar manner to what might usually be expected in an institutionally-focused analysts briefing.

Pleasingly, the questions posited by shareholders were of high quality – this should give other listed issuers the confidence to do something similar when it comes to encouraging retail shareholder engagement. The balance of discount with investor participation was raised in the call; Heine noted that the company was encouraging both investor participation via the offer structure and adopting a long-term view by shareholders when it came to the ongoing development of EROAD.

A few years ago, the saga of Gamestop was at the forefront of investor activism when it came to applying a ‘king hit’ to hedge funds. Gamestop was in a vicious cycle of terminal decline – physical format, video game stores that needed capital that no-one wanted to give them to adapt to a modern world. Less well-known, was that Gamestop subsequently DID raise capital, taking advantage of its newly-elevated share price. Perhaps there is a parallel with EROAD. We are not saying that EROAD is in terminal decline – but perhaps the company is taking advantage of its recently elevated share price.

After all, capital at $0.70 in September still looks a whole lot better than capital at $0.45 in May.

Oliver Mander

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