Do you know Rights Issue of Shares ?
A rights issue is one of the ways by which a company can raise equity share capital among the various types of equity share capital sources available. These are slightly different from the standard issue of shares. Right shares mean the shares where the existing shareholders have the first right to subscribe the shares.
In layman terms, rights issue gives a right to the existing shareholders to purchase additional new shares in the company. Rights Issue of shares are usually issued at a discount as compared to the prevailing traded price in the market. The existing shareholders are allowed a prescribed time limit/date within which need to exercise the right or the right will thereafter be forgone.
Let us have a look at the features of the rights issue, reasons why rights shares are issued, accounting treatment of rights issue and how market price reacts post rights issue. This will help us understand the concept better.
Features of Rights Issue of Shares
The rights shares allow preferential treatment to existing shareholders, where existing shareholders have the right to purchase shares at a lower price on or before a specified date. The shares are issued at a discount as a compensation for the stake dilution that will take place post issue of additional shares. The existing shareholders can trade the rights to other interested market participants until the date at which the new shares can be purchased. The rights are traded in a similar way as the normal equity shares. The amount of rights issue to the shareholders is usually at a proportion of existing holding. The existing shareholders can also choose to ignore the rights; however, one may not do so as existing shareholding will be diluted post issue of additional shares and will result in a loss (in valuation) for existing shareholder.
Why Does a Company Issue Rights Shares?
A company may look to raise a large amount of capital for expansion projects which may have a longer gestation period. A project where debt/loan funding may not be available/suitable or expensive usually makes company to raise capital via this route. Companies looking to improve debt to equity ratio or looking to buy a new company may opt for funding via rights issue route.
Sometimes troubled companies may issue rights shares to pay off debt to ease the financial strain. Having looked at the features, let us look at an example of a rights issue.
Right Issue Example:
Let us say an investor owns 1000 shares of ABC Ltd. and the shares are trading at a price of Rs100 ABC Ltd. announces a rights issue in the ratio of 2 : 5, i.e. each investor holding 5 shares will be eligible for 2 shares from the new issuance. The company announces a discounted price of say Rs 60 per share. This means that for every 5 shares of value Rs 100 held by an existing shareholder, ABC Ltd will offer 2 shares at a discounted price of Rs 60.
Portfolio Value before Rights Issue = 1000 shares X Rs 100 = Rs 1,00,000
No. of Right Shares to Be Received = (1000 X 2/5) = 400 Shares
Cost of Purchasing New Shares Using the Rights = 400 shares X Rs 60 = Rs 24,000
New quantity of shares = 1000 Shares + 400 Shares = 1400 Shares
New portfolio value post right issue = Rs 1,00.000 + Rs 24,000 = Rs 1,24,000
Price per share post rights issue = Rs 1,24,000 / 1400 = Rs 88.6
The theoretical price per share post rights issue equals to Rs 88.6 as against initial price of Rs 100. However, market reaction to rights issue can be slightly different and it is dependent on many other factors.
Let us look at the market price action by a company post rights issue.
Market Price Action Post Rights Issue:
The price action post rights issue depends on various factors that include the reason for the issue of rights share by the company, the future prospects for the growth of the company, the industry outlook, the general market trend etc. among many other things. It, therefore, does not mean that, as the rights issue is given at discount, it may be always beneficial to the existing shareholder.
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