Rights Issues and Open Offers
A rights issue is a way for a quoted company to raise money. Rather than take on debt, it asks its shareholders to dig into their pockets to provide extra capital. There is also a similar method by which companies can raise money called an open offer. We cover this in more detail below.
Both rights issues and open offers are used when a company needs to raise significant amounts of new cash. For smaller amounts, companies tend to use a different method called a placing where discounted shares are offered to major shareholders only.
Understanding Rights Issues
A rights issue is where a company gives all its existing shareholders the right to subscribe to additional shares. As a shareholder, you’re not obliged to participate in a rights issue.
A 1:5 (“one for five”) rights issue means an existing investor can buy one extra share for every five currently held. Every shareholder is offered the same deal, no matter how many shares they hold.
Similar terminology, i.e one for five, is used to describe an open offer.
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. As a shareholder, you can take up all, some or none of the rights on offer.
Why Would A Company Issue A Rights Offering?
Rights issues, and their close cousin open offers, are not common occurrences.
Usually the money is used for corporate expansion, a large takeover of another company frequently being the main reason. At the other end of the scale, companies have used rights issues to shore up their financial position.
Each rights issue comes with a detailed announcement from the company concerned, spelling out how the money raised will be used, the exact process behind how it will work, and a timetable of key dates.
Will I Be Told Of A Rights Issue?
Yes. What’s called a “provisional allotment letter” should be sent to all shareholders, detailing their entitlement to participate.
If your shares are in a nominee account, then your broker should inform you of the rights issue, what your options are, and what actions you need to take in each case.
The company will also issue an official announcement that has a timetable for the various stages of the process, and you’ll probably see news about the rights issue or open offer covered on financial websites.
How Rights Issues Work
Let’s use a simple example and work through the details.
Say you hold 200 shares of RightsCo. The market price of the shares is 100p and the company then announces a “one for four” rights issue. The subscription price for the rights issue is set at 80p.
The value of your holding before the rights issue was:
200 shares at 100p = £200
Take Up the Rights To Purchase In Full
If you took up all your rights, you would purchase 50 new shares at a price of 80p, so the total amount of money you would need is:
50 shares at 80p = £40
A few weeks after the announcement, the original shares will become what is known as “ex-rights”. This means that anyone who subsequently buys them doesn’t have the right to participate in the rights issue.
At this point, the value of the original shares will fall to reflect this. You can estimate the extent of the fall by calculating what is known as the theoretical ex-rights price.
Total value of investment / Total number of shares held
= (£200.00 + £40.00) / (200+50)
Once the transaction is complete, you would have 250 shares worth 96p each, a total of £240. You’ll notice that’s the same as the initial value of the shares you held plus the extra £40 you subscribed for in the rights issue.
That’s the theory, all things being equal.
In practice, the share price will keep on moving in the weeks it takes the rights issue to complete. General market sentiment and how investors perceive the rights issue may move the share price in either direction.
Ignore The Rights Issue
Using the above example, let’s assume you don’t take up any of your rights, either because you don’t approve of the deal or don’t wish to increase your position size.
You remain holding 200 shares but at a theoretical ex-rights price of 96p. The value of your holding would become:
200 shares at 96p = £192
So, it appears you have lost £8, having had a holding of £200 originally. But read on to see why that’s not the case.
Sell Your Rights To Other Investors
Your 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:
Rights price = 96p – 80p = 16p
So, if we ignore dealing costs, by selling the 50 rights, you can recoup your £8:
50 rights at 16p = £8
So effectively your position size in the company has been reduced from £200 to £192, similar to selling a small part of your holding and receiving £8 in cash.
Alternatively, you could do nothing and let the rights issue lapse. At 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 share price could move against you in the meantime. If the share price had fallen to 92p, say if investors disapproved of what the company was planning to do, the rights price would become 12p and the total amount you received would be £6.
Of course, the reverse could happen as well. If the share price rose, you would receive more than £8.
Sell Part Of Your Rights To Other Investors
Another option is to sell part of your rights. You can even use the proceeds from selling some of your rights to take up your remaining rights. This process is known as “swallowing your tail”.
Let’s go back to our example to see how this might work.
You could have sold 42 rights at 16p and raised £6.72. This would allow you to buy the remaining 8 shares at a cost of £6.40. At the end of all this, you would have 208 shares worth 96p each – a total of £199.68 – plus 32p net from selling part of your rights and taking up the rest.
Once again, you end up with £200 in total. It’s financial magic!
Usually, your broker will offer this tail-swallowing option when it asks you what you want to do regarding the rights issue, and it will do all these sums on your behalf.
What Happens To The Historical Financial Records After A Rights Issue?
The shares created under a rights issue or open offer affect “per share” calculations like earnings per share and dividends per share.
When a company reports its results, 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 but with one key difference. Although you are entitled to buy more shares at a lower price, 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.
This means that if you do not take up an open offer, the value of your holding will fall slightly.
Is There Anything Else To Be Wary About With Rights Issues And Open Offers?
As rights issues may require you to buy new shares, you have to have the cash available to do so.
This may be a particular problem if you hold the shares in a Stocks and Shares ISA and you’ve used up your ISA allowance for the current tax year. In this case, if you wanted to participate in the rights issue or open offer, you would have to use any cash balance already within your ISA or sell another holding to raise the required cash.
One other complication that can occur is when the share price in the market drops below the subscription price in the rights issue or open offer. In this case, it’s not worth participating as it would be cheaper to buy shares in the market.
In practice it’s very rare for this to happen, and when it does the company may decide to cancel the right issue process and maybe try again but with a different price structure.
To avoid this happening, some people like to wait until fairly late in the process before deciding whether to take up your rights or not.
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Is a rights issue good or bad?
Each rights issue needs to be examined on its own merits. Most frequently, rights issues are used to fund major company acquisition, so it depends on whether a fair price is being paid and how successful management are in integrating the new business over time.
What is meant by rights issue?
A rights issue is a common method for UK-listed companies to raise additional money from shareholders. They are most often used to fund the acquisition of another company or to help shore up the company’s financial position.
How does a rights issue work?
Rights issues are a way for companies to raise additional money from their shareholders, who have the right (but not the obligation) to purchase more shares in a company at a lower cost. The actual mechanics of the transaction will vary from rights issue to rights issue.
How does a rights issue affect share price?
A rights issue will typically result in a lower share price but this is often compensated for by shareholders getting to buy more shares at a lower cost. How investors perceive the rights issue and how wisely they think the money raised is being used may also affect the share price.