Riding on Rights issue

Implication of Rights Issue

Rights issue is an issue of additional shares by a company to raise capital for
expansion or to solve a liquidity problem. With the issued rights, existing
shareholders have the privilege to buy new shares of a company in proportion to
their existing holding, and at a discounted price.
Shares issued in a rights issue have an exercise price below the prevailing market
price of similar shares.
The company will also set a time limit for the shareholder to buy the share.
If a shareholder does not take the company up on their rights issue then they have
the option to sell their rights on the stock market just as they would sell ordinary
shares, however their shareholding in the company will weaken.

Example 1:
MAA Company has 400,000 $1 ordinary shares as at 30 June 2011. The
company decided to make a rights issue to its existing shareholders by
offering 1 new share for every 4 shares held, at $1.20 each.
Therefore, with 400,000 shares, the rights issue = 400,000 / 4 = 100,000
shares.
The amount received from the issue = 100,000 shares * $1.20 =
$120,000.

Rights are often transferable, allowing the holder to sell them on the
open market.

More on rights
A company will offer more shares to its shareholders to raise
extra money for the company. Companies with a poor cash flow
will often use a rights issue to increase cash flow and pay off
existing debts.
Rights issues however are sometimes issued by companies with
healthy balance sheets in order to fund research and
development projects or to purchase new companies.
Troubled companies typically userights issuesto pay down debt,
especially when they are unable to borrow more money. But not
all companies that pursue rights offerings are shaky. Some with
clean balance sheets use them to fund acquisitions and
growthstrategies.
A company will usually, but not always, have its rights issue
underwritten by investment bank.

 Example 2:
Golden plc. had the following information:
Authorized Capital 5,000,000 $0.50 ordinary shares
Issued Capital 3,000,000 $0.50 ordinary shares
The company decided to make a rights issue of two
ordinary shares for every fifteen ordinary shares held at a
premium of $0.15 each.

Therefore,

with 3,000,000 shares issued, the rights

issue = 3,000,000 * (2/15) = 400,000
shares
The amount received from the issue =
400,000 shares * ($0.50 + 0.15) =
$260,000.

Example of a rights issue of shares : Investors

perspective

Company ABC Mining has 10 million shares at a

share price of $8 (market capitalization $80 million)
JP owns 1,000 shares worth $8,000
ABC Mining needs to raise $30 million to research
new mining locations.
ABC Mining issues 5 million new shares @ $6 each
(to raise $30 million, a 25% discounted price)
This is classed as a 2 to 1 rights issue
Which means every 2 shares you own ABC mining
will issue another 1 share.
This means JP is being issued with the right to buy
further 500 shares at $6 ($3,000)

Rights issue in light with three

choices

JP can either
1. Buy the further 500 shares for $3,000.
2. Ignore ABC Minings rights issue. This will result in JPs share holding will be diluted along
with the value of his current share holding. This option is not usually advised.
3. Sell his rights on the stock market and make a profit (providing the rights are
renounceable, if a company issues non-renounceable rights then they can not be traded

As you can imagine the stock price is likely to change after a

rights issue of shares. This is called the ex-rights share price.
It is possible to estimate the ex rights share price by;
Taking JPs original shareholding of 1000 shares @ $8.00
worth $8,000
Taking JPs new 500 shares @ $6.00 worth $3,000
Adding the total values together $8,000 + $3,000 = $11,000
Dividing the total value ($11,000) by the total number of
shares (1500) = $7.33 per share.

Theoretical Value of
rights
Oasis Ltd. intends to raise 4000000 tk. of equity
capital through a rights offer. It currently has 1000000
shares outstanding which have been most recently
selling for tk. 54. In consultation with BSEC, OL has set
the subscription price for the rights at 50tk.
1. Determine the no. of shares OL should sell to raise
the desired capital.
2. Find out the no. of shares each right would entitle a
holder of one share to purchase? How many additional
shares can an investor buy for having 10000 shares.
3. Compute the TVR when the share is trading at exright.