A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. Rights issues give existing shareholders the option of purchasing new shares often issued at a discount to the prevailing market price.
Quoted companies on the Nigerian stock exchange have in recent times relied on rights issues a way to raise capital. This is especially when you consider that there are other options available to raise capital. Quoted companies also have the option of a public offer, commercial paper, bonds, or even bank debt. Despite these options, most have relied on rights issues as a way of raising capital. Examples are Unilever, Lafarge Wapco, Transcorp, Guinness etc. They have all chosen rights issue as a preferable option.
In this article we will explain why rights issues can be a viable option especially in an economic downturn.
Raising capital can sometimes come at a cost to existing shareholders. Apart from the usual fees and expenses involved, it could mean relinquishing some form of control. For example, if a company goes the debt route, the banks will taken on collateral and in some cases direct the affairs of the company. If it is a public offer, then it means the company will likely add new shareholders thus increasing the number of people who have claims to its earnings. A rights issue however avoids all these pitfalls because it is only sold to existing shareholders of the company. In a rights issue, shares are only sold to existing shareholders based on the existing number of shares they already own. Therefore the risk of dilution is avoided.
Dovetailing from above, right issues are also considered the easiest way to raise capital especially if you want to repay debt. Since the economic crisis that started in 2014, most companies in Nigeria have seen their debt and cost of servicing these debts increase to unbearable levels. Repaying these debt has also become expensive as most investors are wary of the economy. The case of Etisalat and the 13 Nigerian banks is an example. However, if all doors are closed the last resort will always be to go back to existing shareholders who care about the companies to stay afloat.
Cheaper Way of Raising Capital
In a bearish stock market, where it will be difficult for a quoted company to raise money through a secondary offer, embarking on a Rights Issue is a cheaper way of raising funds. This is because the costs of preparing a brochure, underwriting commission, press advertising, and other related service costs involved in a new issue of shares are reduced.
Due to the developments in the financial services industry, banks undertake limited lending at very high interest rates which will expose the company to huge financial costs.
Optimise Balance Sheet and Improve Financial Flexibility
Guinness Nigeria Plc, last year found itself exposed to the challenging operating environment. The company was highly exposed due to its heavy reliance on bank borrowings, which required the payment of huge finance charges worsened as a result of the naira devaluation. Guinness net debt equity ratio jumped from 79.9% to 103.9% as the half year ended Dec 31, 2016.
Earlier this year, a Rights Issue of N40 billion was done to deleverage its balance sheet and reduce the erosion of its earnings through high interest charges.
Fund R&D and Investments
Rights issues are sometimes issued by companies to help increase cashflow, fund research & development, purchase assets or acquire a new company. For example, in a letter to shareholders on how the funds raised from the rights issue will be spent – transcorpnigeria.com/transcorp-lists-rights-issue/
Transcorp Plc stated that funds raised will be mainly used to refinance the company’s investments in the acquisition of Ughelli Power Plc and deepen its play in the hospitality and Oil & Has sector.
Finance Working Capital Needs
Companies can also embark on a Rights Issue to fund working capital needs. UAC of Nigeria Plc proposed a plan for a Rights Issue in May for two of its subsidiaries Grand Cereals Limited and Livestock Feeds. These 2 companies needed working capital support during the procurement season of Nov/Dec which banks may not provide timely as this period coincides with the financial year and of banks, when balance sheet management is important.