Rights Issues and Open Offers
A rights issue is a way for a quoted company to raise money. Rather than take on debt, a quoted company can instead ask its shareholders to dig into their pockets to provide extra capital.
The transaction involves the company giving existing shareholders the right to subscribe to newly issued shares in proportion to their existing holdings. The terminology used here is similar to the share splits, where a 1:5 (“one for five”) rights issue means an existing investor can buy one extra share for every five currently held.
The price of the newly issued shares is fixed, and is always set below the prevailing market price. As the name implies, the issue gives shareholders the right to buy the additional shares, but not the obligation. The rights can be sold on to others who wish to take advantage of the offer, and hence each right has a value. A shareholder can take up all, some or none of the rights on offer.
What causes a rights issue?
They are not common corporate occurrences. Usually the money is used for corporate expansion, a large takeover frequently being the main reason. At the other end of the scale, companies have used rights issues to save themselves from going bust. Some sort of corporate activity or explanation will always accompany a rights issue.
Will I be told of a rights issue?
Yes. What’s called a “provisional allotment letter” will be sent to all shareholders, detailing your entitlement. If your shares are in a nominee account, then your broker should inform you of the rights issue. The company will also issue an official announcement which has a timetable for the various stages of the process.
What happens to the share price of the company involved?
It depends. This is the theory:
An investor holds 200 shares of RightsCo. The market price of the shares stand at 100p and the company then announces a “one for four” rights issue. The subscription price for the extra shares is set at 80p.
The value of the holding before the rights issue was:
200 shares at 100p = £200
To take up all the rights, the investor will have to purchase 50 new shares at a price of 80p, so the total amount of money that will pass from the investor to RightsCo is:
50 shares at 80p = £40
So, after the shares goes ex-rights (usually a few weeks after the initial announcement and meaning that anyone buying them no longer has the right to buy the new shares) the share price, known as the ex-rights share price, will be:
Total value of investment / Total number of shares held
= (£200.00 + £40.00) / (200+50)
That’s the theory, all things being equal. But as mentioned earlier, a rights issue is accompanied by corporate news over why the capital is to be raised. And thus the stock market will take into account that information too. If the money is to be put to really good use, then the share price may rise, even though the prospect of extra shares has a dilutive effect.
What happens if I don’t take up my rights?
Using the above example, assume the investor doesn’t take up any of the rights. The investor will remain holding 200 shares at a theoretical ex-rights price of 96p. The total holding value will be:
200 shares at 96p = £192
So, it appears the investor has lost £8, having had a holding of £200 originally.
But the rights are usually tradeable, meaning you can buy and sell them through a broker, just like you can with ordinary shares. Each right will be worth (in theory) the difference between the subscription price and the ex-rights share price; in this example:
Rights price = 96p – 80p = 16p
So, if we ignore costs, by selling the 50 rights, the investor will recoup his £8:
50 rights at 16p = £8
Alternatively, our investor could do nothing and let the rights issue lapse. And the end of the process, the company takes all the lapsed rights and sells them. Any money raised is returned to the shareholders who let their rights lapse. The disadvantage of this approach is that the price could move against you in the meantime. If the share price had fallen to 92p for example, the rights price would be 12p and the total amount received would be £6.
Another option is to sell part of your rights. You can even use the proceeds to take up your remaining rights. In the above example, our investor could have sold 42 rights at 16p and raised £6.72. This would have enabled him to buy the remaining 8 shares he was entitled to at a cost of £6.40. This process is known as “swallowing your tail”.
What happens to the historical financial records after a rights issue?
Very little. The shares created under a rights issue only affect “per share” calculations like earnings and dividends per share. Previous year earnings and dividends per share data are usually adjusted to reflect the increased number of shares in issue, ensuring the figures are comparable.
What’s an open offer?
An open offer operates in a very similar way to a rights issue. However, although you are entitled to buy more shares, you cannot sell on this entitlement like you can with a rights issue. Similarly, if you let an open offer lapse, you won’t receive any cash.
What’s the difference between a rights issue and share split?
A share split is simply dividing the company pie into more slices, but each investor receives proportionately more slices to compensate. The company pie remains the same size.
In a rights issue, the company pie is enlarged by the raising of additional capital, and investors are asked to pay for more slices. The success, or not, of a rights issue is determined by whether the value and prospects of the enlarged company pie has increased in proportion to the number of extra slices cut (or shares issued).
Is there anything else to be wary about with rights issues?
Yes. Make sure that you don’t take up your rights if the share price has fallen below the subscription price. If that happens it would be cheaper to buy the shares on the open market.
Free investing reports
The Motley Fool can help you invest better. We have several investing reports which are free to access and packed full of useful information on investing strategies and share ideas.