So, what's a rights issue?
It's a way for any listed 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, 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.
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 = £200.00
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 = £40.00
So, after the announcement, and assuming the rights issue is a success, the new share price, known as the ex-rights share price, will be:
Total value of investment £200.00 + £40.00
--------------------------- = ----------------
Total number of shares held 200 + 50
= 96p
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 = £192.00
So, it appears the investor has lost £8.00, having had a holding of £200.00 originally.
But the rights are usually tradeable. 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, by selling the 50 rights entitled to the investor, the investor will recoup his £8.00:
50 rights at 16p = £8.00
What happens to the historical financial records after a rights issue?
Nothing. The shares created under a rights issue will only affect current and future "per share" calculations. Previous earnings and dividends per share data will remain unchanged. In the first year of the rights issue, the per share levels may drop from the previous year, as the capital raised from the rights issue may not lead to an immediate or proportionate increase in profits.
So, in a nutshell, 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. It would be cheaper to buy the shares on the open market.
How can I change my Foolish portfolio if I take up a rights issue?
You just create an extra "buy" transaction in the normal way.
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