The power plays behind National Grid’s easy-money cash call

“A nutless monkey could do your job,” studio mogul Les Grossman (played by Tom Cruise) tells his colleague in the 2008 film Tropic Thunder. “Now go get drunk and take credit at all the parties.”

This sentiment mirrors how investment bankers sometimes feel when a rival lands a coveted mandate. A lot of capital markets work doesn’t require special skill to execute but can be extraordinarily lucrative for the lead underwriter.

Last Thursday, National Grid announced a colossal £7bn fully-underwritten rights issue to help fund a five-year, £60bn investment plan. This is massive: the biggest equity offering of the year and the largest in the UK since the Lloyd’s Bank 2009 rescue rights issue. 

It also means a massive payout for the two lead banks, Barclays and JPMorgan, who stand to rake in up to £140mn in underwriting fees. It is hard to overstate what a home run this deal has been: it’s practically unheard-of to earn a $90mn fee on a single equity offering, much less $4.5bn of league table credit. 

The structure of the deal is straightforward — a fully-underwritten, deeply discounted rights issue. Shareholders get rights (on a 7-for-24 ratio) to buy new shares at a 35 per cent discount. There’s nothing creative here; the deal is as plain vanilla as Robert Van Winkle. Barclays and JPMorgan guarantee the proceeds if there’s any shortfall. No other bank is involved, and — in a break from UK rights issue norms — none of the offering is being sub-underwritten by institutional investors.

The bankers at Barclays and JPMorgan have hit the jackpot, securing yuge fees for minimal risk. Discussing the nearly disastrous Credit Suisse rights in late 2022, FTAV wrote:

The vast majority of rights issues are anticlimaxes. As long as the shares stay well above the subscription price, shareholders have every incentive to exercise the right and buy shares at a discount. And since the underwriting banks aren’t actually selling shares, there is none of the stress or uncertainty of collecting orders and building a book of investor demand, as there is in an IPO or share placement. ….  [A]  sizeable discount is why some investors disparage the fees that banks earn for underwriting as “money for old rope”: the underwriters are pocketing a fee for taking on the very remote risk of being stuck with shares.

Other banks will find the National Grid deal hard to swallow. Heads of investment banking will carry out ruthless stewards’ enquiries, especially if their banks had lent money to National Grid in anticipation of a big payday. At least a dozen full-service investment banks could have underwritten this offering, and so there will be widespread frustration. 

Lending banks weren’t the only party left out in the cold. Normally, up to 30-50 percent of a UK rights issue is sub-underwritten to UK shareholders who collect a roughly 1 per cent fee. Not here. Barclays and JPMorgan were comfortable with the risk and didn’t want to share their fees with institutions. And National Grid didn’t insist on sub-underwriting, either.

It’s worth asking why National Grid snubbed their lenders and shareholders to favour Barclays and JPMorgan to such an extreme. But it probably doesn’t actually matter much that there was no sub-underwriting.

Fund manager investment decisions aren’t driven by a sub-underwriting fee. The practice of paying sub-underwriters is largely a UK phenomenon and has long seemed anachronistic, a relic of a bygone era when the “UK Club’‘ of marquee fund managers held some sway. This rights issue shows that the UK long-only investor community is now regarded as a spent force that no longer has to be placated.

Sidelining lenders, however, is another story. Companies usually spread fees around to ensure continued support from lending banks.  National Grid had £140mn of fees to play with, and Barclays and JPMorgan would have been satisfied with a fraction of the fees they ended up receiving, especially if they could keep the £7bn of league table credit. So why lavish them with the whole fee pool?

Part of the reason may lie with corporate broking – a unique UK practice. London-listed companies appoint (usually) two banks as corporate brokers to serve as capital markets advisors. Corporate brokers to FTSE 350 companies normally work for free, hoping to score a future M&A or capital markets mandate. Corporate broking assignments are the closest thing to a “captive” client situation as you’ll ever see in investment banking.

Another reason is more practical. National Grid sprung the deal on the market by surprise, and it presumably didn’t want to risk a leak or distract their internal teams working flat-out to prepare for the launch. This is understandable, but in such cases companies often offer underwriting tickets immediately post-announcement, along with due diligence materials and take-it-or-leave-it documentation. Even if banks have only a day to give a response, they will get there in time with their underwritings.

Looking from the outside, it is surprising that National Grid showered their two corporate brokers with such a bounty. To be sure, there’s something refreshing about rewarding trusted advisors over the “dumb money” of lending banks. Moreover, Barclays and JPMorgan have probably done a lot of free corporate finance work over the years.

Nevertheless, it’s doubtful that the value of this work comes anywhere close to the fees awarded. And it’s difficult to see the upside of alienating lenders you may need in future. Banks won’t rashly cut credit lines, but there’s no question they will more critically scrutinise future lending requests to determine whether they will earn enough ancillary fee income to justify the commitment.

Another knotty question involves the fee spread – 1.85 per cent base fee plus an incentive fee of 0.15 per cent. As FTAV has discussed elsewhere, a rights issue underwriting is akin to writing a deeply out-the-money put — National Grid have in effect the right until June 12 to sell £7bn worth of shares to Barclays and JPMorgan at 645p. But the “option” is so large, so bespoke and so unhedgeable as to make a Black-Scholes model valuation absurd.

It’s really anyone’s guess what the underwriting is “worth”. The fees here are roughly in line with UK practice and about 50-75bps higher than Continental European rights issues. However, since Barclays and JPMorgan were handed the full economics and league table, National Grid could’ve squeezed harder on fees. Much much harder.

The two leads would likely have accepted, say, 1.25 per cent. Maybe a £50mn saving is a rounding error for a company slated to spend £60bn in capex — especially when it’s not your money — but it seems strange for UK investors to kick up such a fuss over CEO compensation when larger amounts fly out the door with less scrutiny.

A nutless monkey — with a big balance sheet — could’ve underwritten this rights issue, but the real skill in the deal lay in persuading National Grid to pay full fees and exclude other core relationship banks.

Whoever the bankers are: Feel free to go get drunk and take credit at all the parties. Even Les Grossman would think you deserve it.