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Should I buy shares in a rights issue?

If you invest in shares, sooner or later you’re going to face a rights issue. It’s one of the ways a company can raise new cash, by offering new shares to existing shareholders in proportion to their current holding, at a discounted price.

The discount is needed, otherwise there’s no advantage over just buying on the open market. So you’d be silly to turn it down, right? Not necessarily. I’m always cautious when I’m offered something at a fixed price decided by a company, rather than at the price decided by the consensus of buyers and sellers on the open market.

It’s similar to an initial public offering (IPO), or flotation, and there we don’t even have a market price for comparison. It’s easy to see an IPO as an opportunity to get in at the start of something hopefully big. Wouldn’t you love to have been in on the Amazon IPO, for example?

Maximum price

But companies tend to float when markets are up and prices are high, as the intention is to raise as much money as possible. Why would you offer shares in your company when markets are weak and you’re going to get less? You might not be old enough to remember the lastminute.com IPO, when the company doubled its launch price at the last minute — that’s an extreme example, but it’s a handy reminder that sellers at an IPO are there to maximise their take, not to offer us a bargain.

I think of a rights issue in a similar way, and I ask a few questions. Why is the company offering these shares to me at such an attractive discount? Could the money be raised in some other, better, way?

As part of the ongoing funding at Sirius Minerals, we were offered the chance to buy one new share at 15p for every 22 we already held. My holding is so small I didn’t bother, and with the price now down at 10p I did well to avoid it. The problem for Sirius is that it’s having trouble finding takers for its $500m bond offering, and that highlights one thing that can go wrong with a rights issue as part of a fundraising package — if the company can’t sell the entire package, there’s a good chance the share price will tank.

Better result

By contrast, the rapidly-growing Cineworld launched a big rights issue in January 2018 to fund a major US acquisition, offering shareholders the chance to buy four new shares at 157p each for each one they owned. Since then, Cineworld shares have had an erratic ride, climbing above 320p earlier this year before falling back. Today they’re back down to 233p, but those who took up the rights issue have still done well. More importantly, I think the pricing provided a bit of a safety margin for those wanting in on a potentially volatile growth stock.

Whether to buy at a rights issue can only be decided on a case-by-case basis, and I’d always take into account the reason for the fundraising, the state of markets, and institutional sentiment towards the company. But ultimately, I reflect Warren Buffett and ask whether the rights offer is getting me a great company for a good price.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Alan Oscroft owns shares of Sirius Minerals. The Motley Fool UK owns shares of and has recommended Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.