Raising capital via rights issues.

Put very simply, a rights issue is a way for a company to raise additional equity capital by offering its existing shareholders the option or right but not the obligation of purchasing additional equity in the company in a fixed proportion to their existing equity. The company benefits by receiving a fresh infusion of equity capital, and shareholders benefits because rights issues usually have a subscription price set at a discount to prevailing market prices. Additionally subscribing to a rights issue would maintain your proportionate shareholding (the % of the total shares of the company you own). Do note that since share capital dilution is taking place, the earnings per share would be adjusted accordingly.

Case in point – Tata Motors (Used for educational purposes only, no interest at the time of writing this)

Tata Motors - Rights Issue
Tata Motors – Rights Issue (From the SEBI prospectus)

Issue size = no of shares offered (1st row) * issue price (5th row). 

Ex-right date = The date on which a buyer is no longer entitled to rights issue (6th April, 2015 ) two days before book closure date in this case.

Issue duration = The period in which you can choose to exercise your rights.  (April 17th to May 2nd in this case). According to SEBI guidelines it has to be for a minimum of 15 days and a maximum of 30 days.

Theoretical ex right price

This is a theoretical price that the post-right stock should trade at post the rights issue. Actual price might vary somewhat due to changing perceptions and imperfections in the market itself.

TERP = (Market Value of shares prior to rights issue + Cash proceeds raised from rights issue) / Number of shares post rights issue

Why would a company go for a rights issue?

A rights issue is a form of raising fresh equity capital, and the reasons could be many. Usual reasons are that the company wants to pay off debt or use it for capital expenditure. This table in the Q1 2015-2015 filing of Tata motors makes note of the rights issue as well as the planned vs actual utilization of the funds as of that period.

Tata motors - Notes to Q1
Tata motors – Notes to Q1

Whether or not you should subscribe for a rights issue depends on whether you think the business is worth buying a fresh shareholding into at a market price equivalent to the rights offering price. If the company is struggling with a really leveraged balance sheet (as GMR Infra was during its rights issue this year), the rationale for holding on to your existing shareholding would be questionable. Capex reasons are more justifiable, but even so my personal preference would be for a company that could expand through internal accruals and would not need to issue fresh capital for doing so. Read the SEBI document carefully, there is ample information to help you make a decision.

 

 

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