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

8 things you must be aware a when subscribing to a right 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. Normally, companies have a variety of ways to raise equities and rights are one of them. When a company issues rights it raises fresh money and therefore it means that your equity gets 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 important things you must be aware about a rights issue..

 

8 things to be aware about a rights issue..

1.  A rights issue is a fresh issue of shares to the existing shareholders of the company. Normally, if the rights are issued at around the CMP, 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.


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 will reduce. Here is how..

DetailsPre Rights IssueDetailsPost Rights IssueNumber of shares O/S10,000 sharesNumber of shares15,000 sharesNet profits for 2017-18Rs.3,70,000Net profits for 2017-18Rs.3,70,000EPSRs.37 per shareEPSRs.24.67 per shareRights issue1:2
 

 

As can be seen from the above table the rights issue does lead to dilution of the equity and 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 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 will have to be made by 22nd February. If there are any non-trading days in between then the ex-rights date will be pushed back accordingly.

4.  Rights are an option which you may or may not exercise. If you exercise the rights offer you have to pay the amount towards 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 a 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 sharesMarket price of the share before rightsRs.180 (A)Value of the InvestmentRs.180,000Rights Issue ratio1:2Rights 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 remains the same. In case of rights you are actually paying money to buy additional shares, even it is at a discount.

8.  The rights price is normally 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 huge discount to the market price of the stock.
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.
 

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