This is a transcript of David Kuo's recent podcast with Champion Shares' Maynard Paton and Stuart Watson
You can listen to or download this podcast here.
David:
This is Money Talk, the weekly investment podcast from the Motley Fool. I'm David Kuo, and joining me in the podcast cave today is our Editor, Stuart Watson, and our Chief Investment Analyst, Maynard Paton. Welcome to the two of you.
Stuart:
Hi David.
Maynard:
Hi David.
David:
Hello, and are we all sitting comfortably in the cave?
Stuart:
We are, yes.
Maynard:
Yes.
David:
Because today I'd like to talk about rights issues. Now there was a time when investors hardly ever saw a rights issue, but it seems that these days we are getting one a week. So Stuart – what exactly is a rights issue?
Stuart:
Well, a rights issue is one of the three main ways a company can raise more money.
David:
What – beg, steal and borrow?
Stuart:
A little bit like that, you could say. Previously most rights issues were used to raise money for acquisitions, so if one company wanted to buy another company, it would go to the market, and say, "Right, I want £400 million to buy this company", but in recent years what we've seen is companies have got loads and loads of debt, and they actually want to reduce this level of debt to something a bit more manageable, so they've gone back to their shareholders and said, cap in hand, "Can we raise some money so we can pay off our debts?".
David:
So what we have at the moment, Maynard, is different ways in which companies are raising money. Now, one of the things that confuses people is when they hear about one for four and four for one rights issues. Now, can you explain to us what exactly that means?
Maynard:
OK, I'll do my best on that David. One for four rights issues are, if you hold four shares, you have the right to buy one extra share in the rights issue; a four for one is if you have one share, you have the right to buy four extra shares.
David:
So that's it then, yes?
Maynard:
That's it.
David:
It's as simple as that?
Maynard:
Yes.
David:
OK, so how do they go about setting the price for these rights issues?
Maynard:
Well, I don't think there's any strict formula, I think the companies involved think about the actual amount of money they need, let's say £100 million, they'll speak to major shareholders about the discount on offer for the rights issue price, and take it from there really.
David:
There is no magic formula, in other words?
Maynard:
No, no, there's no magic formula, and I think that maybe they would look at doing a one for one rights issue, or maybe a two for one, and take it from there.
David:
"One for all, and all for one" then?
Maynard:
That's right.
David:
So apart from that, what happens to the share price of a company, Stuart, that is having a rights issue?
Stuart:
It's probably easier to look at a simple example. Say you've got a company that's trading at 100 pence …
David:
Right, a pound?
Stuart:
A pound, yes, and then it says, "Right, I want to do a one for one rights issue at 60p", OK, so you think, "Oh, that's fantastic, I've got a chance to buy these shares much cheaper than they're trading at the moment."
David:
40p cheaper than the current price.
Stuart:
But it's not that simple unfortunately, so what will happen is, after a little while, the shares will trade ex-rights, so they will trade without the privilege of buying those cheap shares?
David:
OK.
Stuart:
And then what would happen if all else was equal, the price would then fall to 80p, for example.
David:
Right, that is because everything is ideal, so because they're allowed two shares and the total value of the company is now £1.60 for the two shares, it works out at 80p per share.
Stuart:
Yes, so you've got your one original share at 100p, you've got your new share at 60p, together that's 160p, divide by two, and that is your 80p.
David:
OK, so Maynard, people who are shareholders in the company, are they always informed about rights issues, or are these things kept fairly quiet from them?
Maynard:
They should be informed, they've got a right to be informed. The shareholders will get something called a provisional allotment letter, which tells them about the rights issue.
David:
A "PAL", a provisional allotment letter.
Maynard:
Yes, that's the technical name, and that will tell them the amount of shares that they had the right to buy in the rights issue procedure, switched on shareholders will look at the statement through the Stock Exchange, all these rights issues are published through the Stock Exchange, but companies do send the documents through the post.
David:
So this is even if you have the shares in a nominee account, say in your SIPP, you will still be informed about this?
Maynard:
Any good stockbroker will inform you about rights issues, and about corporate actions.
David:
Right, and do shareholders have to take up these rights?
Maynard:
No, these rights issues just give shareholders the right, but not the obligation, to put more money into the company, they're under no obligation at all.
David:
So what happens, Stuart, if somebody has these shares in an ISA, and they've already fully committed, or rather they've actually used their full allocation in the ISA already? – can they then take up the rights issue?
Stuart:
Probably not, well not in full anyway, because if you've already put all the cash you can into your share ISA for that year, then you need obviously to submit cash to subscribe to these new shares.
David:
But you didn't know there was going to be a rights issue though?
Stuart:
That's one of the drawbacks of the ISAs, and it also applies to things like SIPPs as well, if you have to put new money into that, you may have already used up your allowance for that year.
David:
OK, so what happens if I don't take up the rights issue?
Maynard:
When the rights issue occurs, you get something called a "nil paid right", which is, that's your actual right to buy the full amount, the full share. If you don't take up your right, then you can sell these nil paid rights, these are effectively shares traded on the stock exchange which have a value, because it gives you the right to buy the underlying share, and you can sell those and collect the money from that.
David:
So can you buy somebody else's rights?
Maynard:
They're traded on the market as well, so you can sell those, or you could buy other people's, traded just like a share, but for a short period during the rights issue procedure.
David:
OK, so I'm beginning to get the picture of this now, so if I didn't want to take up my rights completely, can I just sell part of the rights, and then use that to buy the other bit, because I haven't got any cash?
Stuart:
Yes, you can do, and that's often one of the options you're given on your allotment letter, it's called "swallowing your tail"...
David:
Oh my goodness!
Stuart:
... which sounds a bit disgusting!
David:
It's enough to make you choke!
Stuart:
But basically what you do is, you sell a small part of your rights, and then that just gives you enough cash to take up the remaining rights.
David:
OK, so what happens to these shares that are being offered, if they're not taken up – are they just left languishing somewhere? Does the company take them back, or what?
Stuart:
Well most of these issues would be underwritten by a big financial company, so what will happen, if people don't take up the rights, maybe only half the people take up the rights, the underwriters will come in and they will buy the remaining shares, they get a nice fat fee for this.
David:
So these shares that are then taken up by the underwriters, they will hold onto these shares and presumably at some later stage they will just release them back onto the market again?
Stuart:
Yes, they would do, they're not in there holding for the long term, they're in there for the fee basically.
David:
So, I guess the main question for people when they are faced with this question about the rights issue is, "Should I or should I not take up the rights issue?" Personally I'd try and keep some money to one side, because if I'm invested in the company, and I believe that company may need to raise more cash, I want to be able to take that up, but then again sometimes when I invest in companies, and I think, "Well, it's asked for more money – I don't really believe in this company any more", then I don't want to take up the rights issue and I even sell my complete holding altogether.
So, the thing that people want to know is, what do they do? – how do they decide, Maynard, whether or not to go for a rights issue?
Maynard:
Essentially it's just like buying a share from scratch.
David:
But you already own the share?
Maynard:
You already own the share, but obviously there's some news attached to the rights issue, you've got to look at what the companies do with the money, and you've got to assess it from there, so if the company's paying off more debt, maybe its debt troubles are over now, if the rights issue works, or maybe the rights issue is associated with some sort of acquisition, where you think, "OK, are we paying for the acquisition, or it doesn't look good, or they're diversifying", so you've got to take a judgement from that.
David:
So you're saying if the story has changed in some way?
Maynard:
So mainly, maybe the story has changed – you've just got to look at what action the rights issue is for, the money they're raising, and then make an assessment on the company.
David:
Stuart, do you have any idea as to how much money's being raised through rights issues at the moment? – because when I said earlier in the introduction, they almost seem like one a week these days. There must be a tremendous amount of money being from private investors in institutions?
Stuart:
Yes, there has been, it's mostly been banks over the last 18 months, I think there was about £24 billion raised in 2008, mostly RBS.
David:
And where is this money coming from – any idea?
Stuart:
Well, it's pension funds that have got money to invest, they'll sell other shares, they've got contributions coming in all the time, and obviously private investors, some of them have money, and some will be looking to top up their holdings too.
David:
So as far as rights issues are concerned, is there an easy way where investors can say, "I think I should be putting my hand in my pocket here, and buy these rights?" – I mean, taking up these rights?
Stuart:
Well, one thing I would do is look at the timetable of the rights issue, which should be in the document you get, and see how long you've got, and when's the last date you can apply for them, and then you can watch to see what happens with the share price in the market, because if the rights issue isn't well received by the investors, the price will fall, and it could even fall below the level they're trying to raise money at.
David:
And that has happened before, hasn't it?
Stuart:
Yes, HBOS is quite a good example of that, last year I think, when they had a particular problem there, where there was quite a long time between when they initially announced the offer and when it had to be accepted, and all the hedge funds came in, they shorted the shares, and the share price just went lower and lower, and I think it actually ended up in the end below the price they were looking to raise money at, so there was no point then in investors looking to buy these shares, because they could buy them cheaper in the market.
David:
OK, so what then happened to that particular rights issue – did it fail, or did they manage to get it away at some stage, or was there some recovery towards the end of that period?
Stuart:
You're testing my memory now! – I think the underwriters came in and saved the day on that one.
David:
OK, so that's what the underwriters are there for, and also people have to remember that, when they have a rights issue, they have to pay the underwriters a fee for doing so, the underwriters are not there as a charity, are they?
Maynard:
Yes, it's about a 2%, 3% fee, for the recent rights issues.
David:
Now, do you also wonder sometimes, the reason why a company is going for a rights issue is because it may want to pay down debt. Now, if the banks aren't prepared to lend the company money, why should investors have to take on that risk?
Maynard:
That's a good question, I think a lot of companies are already loaded up with too much debt, the thing for investors is, maybe putting in the money through the rights issue could see the company through, look at the share price and what the rights are being offered at. Investors could think, well this could be worth an investment based on the recovery of the company surviving, and doing well in the future.
David:
OK, now fairly recently we saw some figures from the Bank of England that suggested they are lending less money to businesses, well that's the way I read the figures anyway, so can I get prediction from the two of you as to whether or not we will be seeing more rights issues from now until the end of this year?
Stuart:
I think there's quite a few more to come, yeah. Lots of companies, their debt facilities are coming up for renewal, and obviously they're going back to their bank managers, and they're saying, "Can we roll this over?", and the banks are tutting, shaking their heads and that sort of thing. I think Debenhams, which we saw today, as we're recording this podcast, is actually quite a good example. They're still going to get some debt from the bank, but not as much as they've got at the moment, so they need investors to fill that gap.
David:
Debenhams is an example of a company that has close to £1 billion of debt, and I presume they went back to the bank managers, and the bank managers have said, "If you can raise say £300 million, then I'll give you the other £700 million, but if you can't raise the other £300 million, then I'm sorry, you're going to have to do something other than that."
Stuart:
It's like the old saying - a bank manager lends you an umbrella then asks for it back when it's raining!
Maynard:
I think in the past as well, if you think about RBS, they had a £12 billion rights issue in April 2008, and then they had another rights issue I think in October last year as well, a rights issue isn't the end of the story, companies can still come back to the market and raise even more money, they just can't cope with their debts. So, to answer your question, yes, I think there will be more rights issues as well, and looking at some of the newspaper companies and commercial property companies, and look at the money they've raised recently, I don't think it's enough to see them through, it's going to be touch and go for some of them.
David:
Well, I was speaking to one investor fairly recently, and they couldn't quite understand, I mean they were invested in a commercial property company. Now the company maintained its dividend, but at the same time it had a rights issue, so it asked the shareholders for more money, they took that money and then paid it back out again as dividends – does that make sense to you?
Maynard:
No, when you're having a rights issue, you can't be seen paying a dividend. If you're taking money from shareholders, you can't really pay it back straight away.
Stuart:
With these commercial property companies though, they're regarded as income stocks and the funds holding them want an income.
Maynard:
There's certain regulations for REITs as well, because they've got to pay out dividends from their property-related income.
David:
So these are the Real Estate Investment Trust?
Maynard:
Yes, real estate, but generally I wouldn't like to put money into a company and then see it pay out a dividend.
Stuart:
It's an absurd situation where you're taking money on one hand and then giving it back on the other obviously, but that's the way the rules just pan out.
David:
OK, so what the two of you are telling me is that we should be expecting more rights issues going forward, until probably the end of 2009, and maybe even beyond?
Stuart:
Keep your wallet handy!
David:
Well exactly, that was going to be my point, so therefore if you are investing in the stock market, just be prepared, and you may be asked by your company to put your hand in your pocket and get that old cheque book and pen out again.
Stuart:
Very much so.
David:
Well, that was a jolly note to end on, wasn't it? So thank you very much, Stuart, for coming in today, thank you Maynard, and of course I end each podcast with a quote, and today I found one from a man called David Russell, believe it or not there are about six or seven David Russells in Wikipedia, I don't know which one it was, whether it was the sailor, the singer or the innkeeper, but anyway, what he said was: "The hardest thing to learn in life is which bridge to cross and which one to burn." Maynard, do you know which one to cross, which one to burn?
Maynard:
I'm never sure which one to cross, I've burnt a few though.
David:
What about you Stuart – do you know which ones to cross and which ones to burn?
Stuart:
Er … no!
David:
Nor do I, I think we'll learn this through experience. Now, if you have a comment about today's show, please post it on the MoneyTalk podcast blog, which you can find on the front page at www.fool.co.uk, and if you have a suggestion for future shows, do let me know - you can email me at moneytalk@fool.co.uk.
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