This year, more than half a dozen companies have announced rights issues for their shareholders. Let us first understand what these are. Why do companies prefer a rights issue over a follow-on public offer (FPO)? And when should one subscribe for it?
What it is
When a company issues to its existing shareholders the right to buy additional shares of the company, it is called a rights issue. The company offers a specific number of shares, according to the existing number of shares held, at a specified price. Normally, the share is offered at a discount (compared to the prevailing market price) to encourage shareholders to accept the offer. The company also fixes a time limit within which the shareholder needs to express his consent to accept the offer. Simply put, rights issues are shares issued by a company only to its existing shareholders. If an existing shareholder is not interested in accepting the rights offer, he has the option to renounce the rights to an existing, or even someone who is not an existing, shareholder.
A company offers more shares to existing shareholders to raise additional funds. The reasons for raising funds could be many, such as investment in research and development, redemption of debt (so that the company reaches its ideal debt-equity ratio), expansion of the existing business or diversification. Generally, companies prefer a rights issue to an FPO as, under a rights issue, the promoters’ equity holding remains intact. Besides, a rights issue is cheaper than an FPO.
Let us understand the mechanics behind a rights issue. Suppose ABC company has 10 million shares outstanding in the market with a current market price of R80 per share. Now, the company wishes to raise R8 crore to finance its research and development activities. ABC needs to issue 5 million new shares of R6 each (since the company wants to offer a discount of 25% on the current market price). This will result in a 2:1 rights issue, which means that for every two shares owned, an existing shareholder will get another one share. Suppose shareholder X owns 1,000 shares in the
company. In this case, he is issued the right to buy an additional 500 shares
at R6 each.
Now X has the following options: (a) Buy further 500 shares for R3,000; (b) Just ignore ABC pharma’s rights issue. In this