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8 things you must be aware a when subscribing to a right issue

10 Apr 2024

Today, the stock market offers investors ample opportunity to make good gains. In fact, serious and experienced investors often advise young new investors to buy a solid stock and stick with it, not for months, but years, to see real rewards. If you are a savvy investor, you may know a thing or two about investing in stocks, and there is more to investing in stock than just buying it low and selling it high for profit. You should know about other aspects of stock investing, like dividends and a rights issue. 

Know the Difference

Recently, there has been a boom in the subscription of IPOs, or Initial Public Offerings. This is when a private company goes public, offering its shares for the first time for purchase by the general public. This is not a rights issue. If you wish to subscribe to a fresh company that wishes to go public and get listed on the stock exchange, you should be aware of all the variables of an IPO, and the right issue meaning should be fully clear to you. There is a clear difference between a rights issue and an IPO. Investors may wish to invest in a bulk of shares of a new company that is going public for a number of reasons with an IPO, not least of which is that they see the company’s prospects as positive for future returns. On the other hand, a rights issue is the offer of more shares to already existing shareholders of a company, already listed on a stock exchange. 

Something About a Right Issue of Shares

When you purchase a stock, you have no way of knowing what announcements pertaining to that stock will come about in the future. You may purchase stock with the sole intention of investment, hopefully for the long term, to hold and see rewards after a few years. Nonetheless, the stock you have purchased may announce something known as a rights issue, and to make the most of this, you should be aware of what it is. Does it have any positive meaning for you as a stockholder? Do you get certain advantages from the announcement? If you are armed with knowledge about a rights issue, you can make an informed decision about whether to accept the offer of buying more shares from a company in that you already hold stock in. You should note that only if your investment may prove advantageous in the future should you opt for the purchase of more shares. 

What is a Rights Issue?

The stock you purchased last month has just announced a rights issue in the ratio of 1:3. That essentially means that you get the right to purchase shares issued by your company in the ratio of 1 share for 3 shares held by you. So, if you are holding 300 shares of the stock, then you are entitled to buy 100 shares as rights at a price set by the company. Typically, companies have a variety of ways to raise equities, and rights are one of them. When a company issues rights, it raises fresh money, which means that your equity gets diluted. Why diluted? Although you may receive more of a number of shares of a company through any right issue of shares, the fact that the company is offering you a higher proportion of its shares means it is diluting its own stake in the company's holdings. By way of this, you are an investor, so your holdings are (technically) diluted. 

If you are subscribing to a rights issue of shares, you need an understanding of rights issues. There is also a procedure for rights issue of shares. Here are 8 critical things you must be aware of regarding a rights issue..

8 Things to Be Aware Of a Rights Issue - Understanding Rights Issue Meaning

1.  A rights issue is a fresh issue of shares to the existing shareholders of the company. It is not like an IPO (initial public offering) in which shares are issued to the general public for the first time as a company becomes public, This distinction must be made as many individuals get confused as to the purpose of share issuance. Typically, if the rights are issued around the CMP or the current market price, then existing shareholders may not be too interested. Hence companies normally issue rights shares at a fair discount to the CMP so that existing shareholders see value in them. A rights issue is an offer made by the company to buy additional shares of the company. This is not compulsory, and shareholders can refuse to buy additional shares if they do not see any value in the extra shares in their portfolios

2.  When a company comes out with a rights issue, it necessarily leads to dilution of equity of the stock, and therefore the EPS and the ROE (return on equity) will reduce.

Here is how. Details Pre Rights Issue Details Post Rights Issue Number of shares O/S10,000 shares Number of shares 15,000 shares Net profits for 2017-18 Rs.3,70,000 Net profits for 2017-18 Rs.3,70,000 EPS Rs.37 per share EPS Rs.24.67 per share Rights issue 1:2

As can be seen from the above table the rights issue does lead to dilution of the equity. Therefore the EPS of the company falls since the profits are constant.

3.  Rights are offered to only those shareholders whose names exist on the register of shareholders of the company on the record date. That is the cut-off date for the issue of rights shares. 2 days prior to that will be the Ex-Rights date. So, if the record date for the rights issue is 25th February, then the ex-rights date will be 23rd February. Any purchase to qualify for the rights must be made by 22nd February. If there are any non-trading days in between, then the ex-rights date will be pushed back accordingly. This is the key part of the rights issue procedure, and you should be aware of it if you wish to opt for shares in addition to the ones you hold. 

4. A rights issue is an option that you may or may not exercise. If you exercise the rights offer, you have to pay the amount towards the subscription based on the rights price and the number of shares eligible. You also have the right to forfeit the rights issue if you are not interested in adding more shares of the same company.

5.  Since rights represent a privilege or the right of first refusal to the existing shareholders, this right has value. It would be of interest to understand how the value of this right is calculated. Check out the table below:

ParticularsAmountNumber of shares held by Investor X1000 shares market price of the share before rights.180 (A)Value of the InvestmentRs.180,000Rights Issue ratio1:2 Rights issue priceRs.100Number of rights shares500 sharesValue of Rights SharesRs.50,000Total value of shares post rightsRs.2,30,000No. of shares post rights1500 sharesNew cost of sharesRs.153.33 (B)Value of the Right = (A-B) = (180-153.33)Rs.26.67 per share

6.  Rights are traded in the market with a unique ISIN number on the exchanges. The basis for pricing the right is the value of the right, which is Rs.26.67 per share. As a shareholder, you have the right to either subscribe to the shares or even sell the rights in the market under their unique ISIN. You will be approximately value-neutral if you opt to subscribe for the shares or if you choose to sell the rights in the market.

7.  Many investors tend to confuse a rights issue with a bonus issue. They are entirely different. Bonus issues are largely value-neutral. What happens in a bonus is that you transfer money from the free reserves to the share capital. Hence the ROE and the EPS (earnings per share) remain the same. In the case of rights, you are actually paying money to buy additional shares, even if it is at a discount.

8.  What is the issue of shares at premium? The rights issue share price is usually expressed as a premium over the par value of the stock. For example, Piramal Enterprises announced its rights issue in the ratio of 1:23 on 12th December 2017 at a premium of Rs.2378. Since the current par value of the stock is Rs.2, this means the rights issue was at Rs.2380/share. That was still a considerable discount on the market price of the stock.

The Key Consequences of Right Issue of Shares

Companies that find themselves at a place where they need to raise more money are the ones that come out with rights issues. If the company is cash-strapped, then this is a way for a company to raise capital. The rights issue is an invitation to buy more company stock, and investors needn’t feel obligated to purchase shares. 

Shareholders may be compelled to buy more shares in any company in which they already hold shares if they find that their experience of holding stock has yielded good returns. Furthermore, investors who see growth potential in the company whose shares they already own will wish to invest more. Just because a company wishes to raise money with a rights issue does not mean it is a sinking ship. It may simply be raising money for potential growth and expansion, which is a good sign for investors. This is one of the reasons that investors invest in a rights issue. However, there are more compelling reasons that give investors enough of a push to invest in more shares of a company. 

Another major reason to invest in any rights issue is the price at which shares are offered at. Unless the price is “right”, that means offered at a discount, investors will not be compelled to buy more shares. However, a way of looking at a rights issue is that the company gives a shareholder a chance to purchase new shares at a discounted rate relative to the market price. Due to the fact that a company is diluting its stake from the issuance of a rights issue, the stock price is also diluted and may go down in the markets. If the price goes down, there will be more potential investors ready to buy shares, and this may create a demand for these shares in the near future, so the price may even go up. Nonetheless, all this essentially has to do with the mood of investors, and as the stock markets are largely unpredictable places at the best of times, you should do your own research as to the reasons that rights issues are offered, and then make your purchase decisions. 

Looking at Rights Issues Positively

Just because a company wishes to raise cash, it doesn’t mean that company is necessarily in debt. It is important to note that companies often issue rights to buy more stock if they need capital for other reasons. For instance, a company may wish to raise money through an issue of rights to acquire a competitor. Companies also offer rights issues to raise wealth to expand already growing businesses. If reasons like these are linked to rights issues, then investors stand to gain from them in the long run. A positive outlook for the company may be rewarding for any investors. 

In a nutshell, rights offer a very well-established method of raising funds from existing shareholders. As an investor, you need to understand the above nuances. You should always base your investment decisions on your own goals and budget for investing. If you have already invested in a robust company’s stock and it is offering you a rights issue, then you should go ahead and buy more of the stock, especially in a large-cap company with a long-term investment view in mind. Provided you have the funds to spare, it is a good idea to invest in a rights issue with such considerations. 

 

Related Articles: What is Right Issue and how to apply for Right Issue? | Invest in Stock Market: Avoiding the Pitfalls of Quick Profit Strategies

 

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