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The cost of obduracy

12 November 2008 By Hugo Dixon

Barclays board thought it was being very clever in not taking advantage of the UK government s bailout. But three weeks on, it is not looking smart at all. The decision to raise £5.8bn super-expensively from the Middle East has inflicted a £2bn cost on other shareholders, according to a breakingviews analysis.

The hit comes from four sources. The biggest is Barclays decision to sell £2.8bn of mandatory convertible notes to investors from Abu Dhabi and Qatar at a deep discount. The bank is essentially selling them 1.83bn shares except there is a seven-month delay before the notes turn into ordinary equity. The price at which these notes convert is 153p. But when you take into account the fact that these notes will pay a 9.75% coupon until they convert, Barclays will only be receiving 145p.

Now imagine what would have happened if, instead, Barclays had taken the government s bailout. It would have been able to sell shares to the taxpayer at a 8.5% discount to its then share price of 208p or 190p. If it had sold the same 1.83bn shares at that higher price, it would have raised an extra £820m.

The second hit comes from a huge pile of warrants Barclays has given the Abu Dhabi and Qatari sheikhs. These investors get the chance to buy 1.52bn shares at a price of 198p. This may not look like a bargain since it is above the 179p to which Barclays shares sank on Friday. But the sheikhs have five years to exercise this option. And remember: it is an option not an obligation.

Using a standard Black-Scholes option model and a volatility of 35% – more than Barclays recent volatility but less than what is used to be – each warrant is worth 50p. Given there are 1.52bn of warrants, that s another £760m hit.

The third hit comes from the nose-bleed price that Barclays is paying on £3bn of reserve capital instruments. The bank is paying a 14% coupon on this debt. What s more, it has to pay this 14% for ten and a half years with no way out. Now compare that to the UK bailout. Under that, Barclays would have had to issue the government with preference shares with a 12% coupon. Although these would not have been tax-deductible, the bank would have been able to pay them off as soon as it could raise the cash.

Now imagine Barclays had managed to get the government s prefs off its back after two years. Imagine, too, that it had then been able to go out onto the market when things had calmed down and issue debt at 10% before tax to replace this capital. One can then work out the extra interest Barclays is suffering as a result of turning to its Middle Eastern friends. Even after tax, it is £680m. And even after discounting this for the time value of money, the hit works out at £330m.

The final hit comes from fees. Just looking at the fees Barclays is paying to Abu Dhabi and Qatar for committing to invest (and not counting advisors fees that it would presumably have had to pay if it had gone to the UK government for cash), that comes to another £240m.

Tot it all up and the grand total is £2.2bn. Now the Qataris are already shareholders with an 8.1% stake. But even factoring that into the equation, the thwack to other shareholders is £2bn. The board is supposed to serve shareholders. It has made a real hash of its job.


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