Understanding Rights Issue

WHAT IS IT?

A rights issue is an issue of new shares for cash to existing shareholders in proportion to their existing holdings. A rights issue is, therefore, a way of raising new cash from shareholders – this is an important source of new equity funding for publicly quoted companies.

Legally a rights issue must be made before a new issue to the public. This is because existing shareholders have the “right of first refusal” (otherwise known as a “preemption right”) on the new shares. By taking these preemption rights up, existing shareholders can maintain their existing percentage holding in the company. However, shareholders can, and often do, waive these rights, by selling them to others. Shareholders can also vote to rescind their preemption rights.

WHAT’S NOT GREAT ABOUT A RIGHTS ISSUE

The shares do not come free of cost. A rights issue will need you to buy the shares. They do not come free. For shareholders – the earnings per share will reduce since there are now more shares for the same earnings, and so will the dividends.  Whenever a company comes out with a rights issue you have to evaluate it to see whether it makes sense for you to subscribe to it. Subscribe to a rights issue only if you really trust in the company’s performance. Don’t just buy it because you are getting it cheaper that market price. Try to find out why the company is coming out with a rights issue. If the company needs this to raise money for a sound business plan that will eventually increase the profits and share price, then it is good.

  • You can choose to subscribe to all of the shares you are eligible for, or a part of them.

WHAT’S GREAT ABOUT A RIGHTS ISSUE..

The good news is that the shares will be cheaper than the current market rate.

When a company offers new shares via a rights issue, it is usually at a discount to the current market rate.

What this means is that if the market price of the share is Rs 500, the company may offer the shares for Rs 450. So you get more shares at a cheaper rate than what you would get if you buy it from the market.

Generally, when a rights issue is announced, the price will go up because investors now want to buy the shares so that they can avail of the rights issue.

WHAT HAPPENS TO SHARE PRICES AFTER RIGHTS ISSUE?

After the right issue is offered price of that particular stock falls in the stock market. It happens because the number of stock of that company increases in the market. Especially if the number of the right issue is relatively higher than the paid-up capital the price falls. Moreover the dividend yield and the PE ratio of that particular stock also falls after the right issue is offered.

Theoretically the right issue does not give significant profit to the shareholders in spite of the fact that they get the stock in lower price. But in practice the shareholders always find the right issue an attractive option to buy the shares of the company. This is because the presume that the company is going to utilize the additional fund from the right issue for further development and expansion of the company that will eventually strengthen the financial standing of the company.

To sum up -

A rights issue has the following effects on the price of a stock.

1. Share capital gets increased according to the rights issue ratio.
2. Liquidity in the stock increases.
3. Effective Earnings per share, Book Value and other per share values stand reduced.
4. Markets take the action usually as a favorable act.
5. Market price gets adjusted on issue of rights shares.
6. Company gets better cash flow which may be used to improve the business and may help increase effective Earnings per share.
7. Usually a shareholder may not back out from applying for the rights issue unless the offer is almost same as the prevailing market price. This is because if a stock is trading at 100 and a rights issue in the ratio 1:1 at a price of 40 will make the stock trade at 70 soon after the ex-rights date.

THE RECORD DATE.

The company will make an announcement that it is offering the rights issue to all shareholders (those who own the shares of the company) on a particular date. This date is called the record date.

After the rights announcement but before the record date, the shares are known as cum-rights. Even if you do not currently own the shares but if you buy them at that time, you will get the rights issue. On the record date, they become ex-rights. If you buy them after this day, you do not get the rights issue.

The dates follow the same logic as discussed in our article on bonus shares.

CONCLUSION

  • Choose to subscribe for a rights issue only if it’s right for you
  • Do not subscribe just because it comes at a lower price.
  • You can exercise your right partially also

You may like these posts:

  1. Bonus shares – A positive sign.
  2. How is a bonus issue different from a stock split?
  3. Benefits of owning shares

5 Responses to “Understanding Rights Issue”

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November 2, 2011 at 3:41 pm

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November 2, 2011 at 3:53 pm

I was very happy to find this web-site.I wished to thanks on your time for this glorious read!!

Riro Jeremy

June 28, 2012 at 12:48 pm

good insight,…very helpful and eye opening….than you very much

Stanley

August 12, 2013 at 2:06 am

Thank you brother

Roshni

March 2, 2017 at 1:40 pm

Hello Victor,
Thanks for the article. Very informative.
I’ve two questions related to the topic:
1) What is the meaning of renunciation (form for renunciation came along with form for application)?
2) If the record date is as you explained how come the form was delivered on issue opening date which was 10 days after record date?
(referring to Canara bank rights issue)
Thanks.

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