It’s nearly decision time for HBOS shareholders. Should they take up their rights to buy new shares in the ailing bank?
It’s been a drawn-out saga, but the rights issue at HBOS (LSE: HBOS) is now entering the final stretch. Shareholders without share certificates have until 11am on Friday 11 July to return their Form of Election saying whether how they want to proceed. Shareholders with share certificates have until 11am on Friday 18 July.
But what people should do remains far from clear. There are four basic options:
1. You take up your rights, sending off a cheque for the full amount
2. You partially take up your rights. In practice, you sell most of your rights and use the proceeds to buy some shares. This process is sometimes called tail swallowing.
3. You sell all your rights and receive the proceeds which will depend on the market price at that time.
4. You do nothing and, at the end of the rights issue process, your rights are sold and you receive the proceeds.
Under UK law, whenever a company wants to issue a substantial amount of new shares, existing shareholders get first dibs. These are known as pre-emption rights. Usually the price at which the new shares are offered is at a substantial discount to the current market price. Therefore, at first glance, it may seem like you’re getting something for nothing. You can buy shares at a discount and sell them for a profit.
What actually happens is that, all else being equal, the price of your original shares falls by the same amount as the profit you would make. No free lunch here I’m afraid. This also means that the price of the new shares doesn’t really matter.
What you’re really being asked is whether you want to put more money into a company (option 1), keep it the same (option 2) or take some out (option 3 and 4).
However, when the share price falls between the announcement and completion of the rights issue there is an additional complication. If the share price falls below the rights issue price there is no point taking up your rights as you can buy the shares more cheaply on the open market. This is why it often pays to wait and see what happens with a rights issue rather than making a decision straight away. A share price fall of this magnitude also means there will be no money available to fund option 2 and no sale proceeds from options 3 and 4.
In HBOS’s case, its shares were at 496p when it offered shareholders the chance to buy 2 new shares for every 5 held for a price of 275p. This was a massive 45% discount but the stock market has sunk over the past couple of months and speculators have helped drive HBOS’s shares down even further. The problem has been exasperated by the additional time the right issue process has taken due to the huge amount of private shareholders HBOS has. As I type, the shares are trading at 273p which is 2p lower than the rights issue price. They have been as low as 249p.
So, at this level, shareholders who intended to take up their rights are faced with a bit of a dilemma. At the moment it costs about the same to take up your rights or buy your shares on the open market. But if the share price falls further over the next fortnight you could end up overpaying for your new shares and wasting some of your money. Shareholders in Bradford & Bingley (LSE: BB) are in much the same position, following the latest news regarding its rights issue.
My crystal ball is on the blink at the moment, so I don’t know what will happen to the share price of either company over the next couple of weeks. My instinct however would be to play it safe and not to take up any rights. Both HBOS and B&B will still get the money they need from the underwriters of the two transactions. Of the two I would say HBOS has much better recovery prospects but both companies will face tough times over the next few years.
More: I’m Not Buying Banks | HBOS Hopes For A Recovery
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