Rights Issue

In our quest to understand the corporate actions of the company, our caravan has moved to rights issue, so today lets deep dive in understanding what rights issue is, how it works, and what is rights renunciation?

What is a Right Issue?

A Right Issue is a corporate action where a company offers its existing shareholders the opportunity to purchase additional shares at a predetermined price, typically lower than the market rate. This move aims to raise capital efficiently. The company is giving shareholders a chance to increase their exposure to the stock at a discount price.

Let’s understand how right issue works better with the help of an example: -

Let’s say an investor owns 100 shares of XYZ Ltd. and the shares are trading at 100 Rs. each. The company announces a rights issue in the ratio of 2 for 5, i.e., each investor holding 5 shares will be eligible to buy 2 new shares. The company announces a discounted price of, for example, 60 Rs. per share. It means that for every 5 shares (at 100 Rs each) held by an existing shareholder, the company will offer 2 shares at a discounted price of 60 Rs.

· Investor’s Portfolio Value (before rights issue) = 100 shares x 100 Rs. = Rs.10,000
· Number of right shares to be received = (100 x 2/5) = 40
· Price paid to buy rights shares = 40 shares x 60 Rs. = 2,400 Rs.
· Total number of shares after exercising rights issue = 100 + 40 = 140
· Revised Value of the portfolio after exercising rights issue = 10,000 Rs. + 2,400 Rs. = Rs.12,400
· Should be price per share post-rights issue = 12,400 Rs. / 140 = 88.57 Rs.

According to theory, the price of the share after the rights issue should be INR 88.57, but that is not how the markets behave. An uptrend in the share price will benefit the investor, while a decline in share price can hurt.

There are different types of rights issues, and they can vary based on the structure and purpose. Here are some common types:

1. Renounceable Rights Issue
In a renounceable rights issue, shareholders have the option to sell their rights to someone else. This means that if a shareholder does not wish to purchase additional shares, they can sell their rights on the open market. 

2. Capped Rights Issue
A capped rights issue sets a limit on the number of additional shares a shareholder can purchase, regardless of the number of shares they hold. This is done to prevent any one shareholder from gaining excessive control. 

3. Rights Offering with Warrants
Some rights issues may include warrants, which give shareholders the right to buy additional shares at a predetermined price within a specified period. This provides additional flexibility for shareholders. 

4. Rights Issue for Specific Purposes
Companies may issue rights for specific purposes, such as funding a particular project, reducing debt, or making an acquisition. The funds raised through the rights issue are earmarked for the specified purpose.

After the understanding the types of rights issue, now let us understand some important factors related to right issue:

The announcement outlines key details such as the purpose of the rights issue (viz. expanding product line), the number of additional shares to be issued, the subscription price, and the duration of the subscription period.

1. Record Date
The company sets a record date, say, two weeks from the date of the announcement. Shareholders who hold shares on or before this record date will be eligible to participate in the rights issue. 

2. Subscription Period
Say, the subscription period is set for one month, starting two weeks after the record date. During this period, eligible shareholders can exercise their right to purchase additional shares at the predetermined subscription price. 

3. Subscription Price
The company sets the subscription price at a 40% discount to the current market price. Suppose the market price of a share is INR100 per share at the time of the rights issue announcement; the subscription price is, therefore, INR 60 per share.

4. Investor Decision Making:
Shareholders now face a decision: As a shareholder you have three options with a right issue-
a. Shareholder subscribe to the rights issue in full,
b. Ignore your rights, or
c. Sell the rights to someone else.

Some shareholders may choose to exercise their rights, seeing it as an opportunity to increase their ownership in the company at a favorable price. Others may decide not to participate, perhaps due to financial constraints or a different investment strategy.

Shareholders who choose not to participate in the rights issue will experience dilution in their ownership stake because the total number of outstanding shares increases. However, those who subscribe to the rights issue maintain or increase their ownership percentage, and the company secures the capital needed for its expansion.

Now, you may to know why Companies opt for Right Issues:

1. Capital Infusion
One of the primary reasons for a rights issue is to raise additional capital. Companies may need funds for various purposes such as funding expansion projects, launching new product lines, reducing debt, or strengthening their financial position. 

2. Debt Reduction and Restructuring
Companies may use the proceeds from a rights issue to reduce existing debt or to restructure their balance sheets. By replacing debt with equity, they can improve their financial flexibility and reduce interest expenses.

3. Strategic Initiatives
Rights issues are often employed to fund strategic initiatives, including mergers and acquisitions, research and development, and technological upgrades. This allows companies to pursue growth opportunities and stay competitive in their industries. 

4. Flexibility in Fundraising
Rights issues provide companies with a flexible way to raise capital. The decision to participate is in the hands of individual shareholders, allowing them to tailor their investment to their financial situation and confidence in the company's future prospects.

Impact of rights issues on shareholders: 

1. Dilution of Ownership
If shareholders don't participate in the rights issue, shareholders ownership percentage in the company may decrease.

2. Opportunity to Invest More
Shareholders have the chance to buy more shares at a discounted price through the rights issue. 

3. Choice to Participate
It's shareholders decision whether to participate or not. 

4. Company Growth and Stability
Funds from the rights issue help the company grow or manage debt, potentially stabilizing its financial health. 

5. Market Price Impact
The market price of the stock might be influenced by the rights issue.

To conclude, a rights issue is a strategic financial move that benefits both companies and their shareholders. By offering existing investors the chance to increase their stake at a discounted rate, companies can efficiently raise capital, while shareholders have the opportunity to enhance their investment portfolio. Understanding this corporate action empowers investors to make informed decisions in the ever-evolving landscape of financial markets.

While the benefits are evident, shareholders need to carefully evaluate the terms of the Right Issue, considering factors like the discounted price, their financial capacity to subscribe to additional shares, and the company's future outlook.

To understand more about such interesting concepts along with further interesting examples, check out my course on Basics of Stock Market.

Until next time !!!