The Nigerian capital market has seen a resurgence of capital raising efforts by most companies quoted on the floor of the Nigerian Stock Exchange. Typically, companies raise money from the capital market via initial public offering, public offering or rights issues. If you are a shareholder of a bank, you may have been inundated by calls by your account officer or broker requesting that you invest in their rights issue. In this article, we will be looking at Right Issues as it affects shareholders of a company.
What is a rights issue?
A rights issue is an offer of new shares from a company to existing shareholders of the company on or before a prescribed date in proportion to their existing shareholdings. For example, a company may be offering a 1 for 3 rights issue meaning that if you own 100 shares in that company, you have the right to purchase additional 33 units.
How is it priced?
Rights Issues are typically priced at a discount to the market price of the stock as an incentive to the shareholder to buy the stock. You can see a stock trading at N10 per share selling a rights issue at N9.50 per share. Some companies also introduce their rights issues at a price equal to or higher than the market price. In this case they often believe the stock is undervalued and will hope that the share price rises above the right issue price during the period of the sale.
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. Also, in the event that a rights issue price is at discount to the market price, it gives you an opportunity to buy your company’s shares at a cheaper price to what it is trading for on the floor of the stock market.
What if I don’t take up my rights?
When you don’t take up your rights, you forfeit it and someone else is likely to buy it. However, in the event that you wish to buy back the shares you can only buy it on the floor of the stock market and hope 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 market price?
This is very possible when the market believes that the rights issue price is not right. There could also be several other reasons for this as the markets can act irrationally depending on market conditions at the time. A rights issue price higher than the market price, makes a rights issue highly unattractive and a disincentive for most retail investors to buy. Rather than take up your rights at a higher price, an investor could easily just buy the stock in the open market at a cheaper price. In the past, companies are placed on a technical suspension and their share price frozen during a rights issue. This artificially kept rights issue price at a discount to market price and was viewed to not be in line with good practice by regulators. If you are therefore offered a rights issue, it is important that you compare the rights issue price with the current market price of the stock.
Does it cost me to buy rights issue?
Buying a rights issue excludes you from paying brokerage fees and commissions which can cost as much as 2.3% per trade. Rights issues are designed to cost little or nothing to shareholders and is an added incentive to consider when you decide between taking up your rights and buying at market price.
What do they use the money for?
Companies who sell rights issue typically state what they will use the money for in their offer prospectus. They can use it to finance working capital, pay back expensive debt, increase capital expenditure, finance new projects, invest in research and development, shore up capital requirements etc. Equity is an expensive for 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 one that is wasteful.
Will the shares be allotted to me on time?
In the past, after you subscribe for a rights issue, you will have to wait for months to be allotted your shares and sent your share certificates. This was particularly annoying for investors who were hoping to take advantage by selling the shares at a higher market price to the rights issue price. Recently, companies offer an option for the shares to be credited to your CSCS accounts instead of waiting endlessly for share certificates.
Conclusion
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.