The Nigerian capital market has seen a resurgence of capital-raising efforts by many companies listed on the Nigerian Exchange.
Typically, companies raise money from the capital market through initial public offerings (IPOs), public offerings, or rights issues.
If you are a shareholder of a bank, you may have been inundated with calls from your account officer or broker, requesting that you invest in their rights issue. In this article, we will explore rights issues as they affect shareholders of a company.
What is a Rights Issue?
A rights issue is a corporate action where a company offers new shares to its existing shareholders, allowing them to purchase additional shares at a discounted price, typically on or before a specified date and in proportion to their current holdings.
- This is a common method for companies to raise additional capital.For instance, consider a company that announces a 1-for-3 rights issue. This means that for every three shares a shareholder currently owns, they have the right to purchase one additional share.
Here’s how it works:
- Current Holdings: If you own 100 shares, you are entitled to buy 33 new shares (100 shares / 3).
- Rights Entitlement: The new shares are usually offered at a price lower than the current market price. If the market price is N10 per share, the rights issue might be priced at N9.50 per share.
- Purchase Decision: You can decide to buy the 33 new shares at N9.50 each.
- New Holdings: If you exercise your rights, your total holdings will increase to 133 shares (100 existing + 33 new shares).
How is it Priced?
Rights issues are typically priced at a discount to the market price of the stock to incentivize shareholders to buy the stock.
- For instance, you might see a stock trading at N10 per share, with a rights issue priced at N9.50 per share.
- Some companies also introduce their rights issues at a price equal to or higher than the market price.
- In such cases, they often believe the stock is undervalued and hope that the share price rises above the rights issue price during the sale period.
Why Should I Buy a Rights Issue?
Because a rights issue represents an internal sale of shares to existing shareholders, taking up your rights ensures that you are not diluted by other shareholders.
- Additionally, if the rights issue price is at a discount to the market price, it provides an opportunity to buy your company’s shares at a cheaper price than what it is trading for on the stock market.
What if I Don’t Take Up My Rights?
If you don’t take up your rights, you forfeit them, and someone else is likely to buy them.
- If you wish to buy back the shares later, you can only do so on the stock market, hoping that the market price is cheaper than the rights issue price; otherwise, you will be buying the shares at a premium.
What if the Rights Issue Price is Higher than the Market Price?
This situation is possible when the market believes that the rights issue price is not appropriate.
- There could be various reasons for this, as markets can act irrationally depending on the conditions at the time.
- A rights issue price higher than the market price makes it unattractive and disincentivizes most retail investors from buying.
- Rather than take up your rights at a higher price, an investor could easily buy the stock in the open market at a cheaper price.
- In the past, companies were placed on technical suspension and their share prices frozen during a rights issue.
- This artificially kept the rights issue price at a discount to the market price and was viewed unfavorably by regulators.
- Therefore, if you are offered a rights issue, it is important to compare the rights issue price with the current market price of the stock.
Does it Cost Me to Buy a Rights Issue?
Buying a rights issue exempts you from paying brokerage fees and commissions, which can cost as much as 2% per trade if you were buying in the open market.
- Rights issues are designed to cost little or nothing to shareholders, providing an added incentive when deciding between taking up your rights and buying at market price.
What Do They Use the Money For?
Companies that offer rights issues typically state their intended use of the funds in their offer prospectus.
- They may use the funds to finance working capital, pay off expensive debt, increase capital expenditure, finance new projects, invest in research and development, shore up capital requirements, etc.
- Equity is an expensive form of capital, so it is important to find out why your company requires additional capital, as that may also be a sign of an ailing company.
- A company that consistently seeks equity capital without a commensurate increase in revenue, profits, or returns on equity may suggest inefficiency.
Will the Shares Be Allotted to Me on Time?
In the past, after subscribing to a rights issue, investors had to wait for months to be allotted their shares and sent share certificates.
- This was particularly frustrating for investors hoping to take advantage of selling the shares at a higher market price than the rights issue price.
- Recently, companies offer the option for the shares to be credited to your CSCS accounts instead of waiting endlessly for share certificates.
Key Takeaway
From the above, you observe that the major factors to consider before buying a rights issue are the rights issue price compared to the market price of the stock, what the company is using the rights issue for, the potential for the share price to rise above the rights issue price and risk of not being diluted.
- If the rights issue fails to meet your minimum requirement then you can consider other options.
- Evaluating these factors comprehensively will help you make a well-informed decision regarding participation in a rights issue.
- By carefully considering the rights issue price, the intended use of funds, potential for share price appreciation, and risk of dilution, you can determine whether participating in the rights issue aligns with your investment strategy and financial goals.
- If the rights issue does not meet your minimum requirements, you may explore alternative investment options that better suit your needs.
Note: This article was first published in Nairametrics on the 27th of February 2015. It has been updated to reflect new information.
No need to bother about rights issue. Just go to your online trading portal and buy shares from the NSE as much as you want.