Rights issue

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Under a secondary market offering or seasoned equity offering of shares to raise money, a company can opt for a rights issue to raise capital. The rights issue is a special form of shelf offering or shelf registration. With the issued rights, existing shareholders have the privilege to buy a specified number of new shares from the firm at a specified price within a specified time.^[1] A rights issue is in contrast to an initial public offering (primary market offering), where shares are issued to the general public through market exchanges.

How it works

A rights issue is directly offered to all shareholders of record or through broker dealers of record and may be exercised in full or partially. Subscription rights may either be transferable, allowing the subscription-right-holder to sell them privately, on the open market or not at all. A right issuance to shareholders is generally issued as a tax-free dividend on a ratio basis (e.g. a dividend of one subscription right for one share of Common stock issued and outstanding). Because the company receives shareholders' money in exchange for shares, a rights issue is a source of capital.

Considerations

Issue rights the financial manager has to consider:

• Engaging a Dealer-Manager or Broker Dealer to manage the Offering processes
• Selling Group and broker dealer participation
• Subscription price per new share
• Number of new shares to be sold
• The value of rights vs. trading price of the subscription rights
• The effect of rights on the value of the current share
• The effect of rights to shareholders of record and new shareholders and right-holders

Underwriting

Rights issues may be underwritten. The role of the underwriter is to guarantee that the funds sought by the company will be raised. The agreement between the underwriter and the company is set out in a formal underwriting agreement. Typical terms of an underwriting require the underwriter to subscribe for any shares offered but not taken up by shareholders. The underwriting agreement will normally enable the underwriter to terminate its obligations in defined circumstances. A sub-underwriter in turn sub-underwrites some or all of the obligations of the main underwriter; the underwriter passes its risk to the sub-underwriter by requiring the sub-underwriter to subscribe for or purchase a portion of the shares for which the underwriter is obliged to subscribe in the event of a shortfall. Underwriters and sub-underwriters may be financial institutions, stock-brokers, major shareholders of the company or other related or unrelated parties. The Panel’s guidance covers both non-underwritten and underwritten rights issues.

Basic example

An investor: Mr. A had 100 shares of company X at a total investment of $40,000, assuming he purchased the shares at $400 per share.

Assuming a 1:1 subscription rights issue at an offer price of $200, Mr. A will be notified by a broker dealer that he has the option to subscribe for an additional 100 shares of Common stock of the company at the offer price. Now, if he exercises his option, he would have to pay an additional $20,000 in order to acquire the shares, thus effectively bringing his average cost of acquisition for the 200 shares to $300 per share ((40,000+20,000)/200=300). Although the price on the stock markets should reflect a new price of $300 (see below), the investor is actually not making any profit nor any loss.

The company: Company X has 100 million outstanding shares. The share price currently quoted on the stock exchanges is $400 thus the market capitalization of the stock would be $40 billion (outstanding shares times share price).

If all the shareholders of the company choose to exercise their stock option, the company's outstanding shares would increase to 200 million. The market capitalization of the stock would increase to $60 billion (previous market capitalization + cash received from owners of rights converting their rights to shares), implying a share price of $300 ($60 billion / 200 million shares). If the company were to do nothing with the raised money, its Earnings per share (EPS) would be reduced by half. However, if the equity raised by the company is reinvested (e.g. to acquire another company), the EPS may be impacted depending upon the outcome of the reinvestment.

See also

• Stock dilution
• Warrant (finance)
• Share Purchase Plan

References

External Links

Rights issue explanation