What is Rights Issue? And Why you should never miss a rights issue?
What is Rights Issue? And Why you should never miss a rights issue?
Rights issue is one of the way to raise funds for publically listed companies. Through this mode, the company makes an offer to existing shareholders to buy additional shares in the company at a discounted price (rights offer price) within a prescribed period. Unlike IPO, a rights issue is not offered to the general public, but only to the existing shareholders in proportion of their existing holdings.
This gives existing shareholders “rights”. With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date. This way the company is giving shareholders a chance to increase their exposure to the stock at a discount price.
The eligible shareholders can either subscribe to the rights issue partly or fully; or they can just sell the rights. If you don’t use the right, it will go worthless. So if you don’t intent to use the rights, you can always sell it in the open market and earn some profits.
Until the date at which the new shares can be purchased, shareholders may trade the rights on the market the same way that they would trade ordinary shares.
How Rights Issues Work?
So, how do rights issues work? Let’s say you own 1,000 shares in Reliance, each of which is worth 2000. The company needs to raise cash for expansion or debt settlement and announces a rights offering through which it plans to raise 100 crores by issuing 10 Lakh shares to existing investors at a price of 1000 each. But this issue is a one-for-10 rights issue. In other words, for every 10 shares you hold, Reliance is offering you another one at a deeply discounted price of 1000 rupees. This price is 50% less than the market price of 2000 rupees at which Reliance stock is currently trading.
As a shareholder, you have three options with a rights issue. You can (1) subscribe to the rights issue in full, (2) ignore your rights, or (3) sell the rights to someone else. we can explore each option and the possible outcomes.
1. Take Up the Rights to Purchase in Full
To take advantage of the rights issue in full, you would need to spend 1000 rupees for every Reliance share that you are entitled to purchase under the issue. As you hold 1,000 shares, you can buy up to 100 new shares (one shares for every 10 you already own) at the discounted price of 1000, so you need to invest 1,00,000 rupees additionally.
However, while the discount on the newly issued shares is 50%, the market price of Reliance shares will not be 2000 after the rights issue is complete. The value of each share will be diluted as a result of the increased number of shares issued. To see if the rights issue does, in fact, give a material discount, you need to estimate how much Reliance’s share price will be diluted once the rights issue hits the market. But remember, the loss on your existing shareholding is offset exactly by the gain in share value on the new rights. This works exactly like share spilt or bonus or dividend.
2. Ignore the Rights Issue
You may not have the 1L to purchase the additional 100 shares at 1K each, so you can always let your rights expire. But this is not normally recommended. If you choose to do nothing, your shareholding will be diluted thanks to the extra shares issued by the company. So you are losing money here
3. Sell Your Rights to Other Investors
In most cases, your rights allow you to decide whether you want to take up the option to buy the shares or sell your rights to other investors. Determining how much you may gain by selling the rights is difficult as rights are trades just like shares in the open market.
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