The phones have been ringing off the hook this last week, you would think we are in a “war room” as we have been inundated by calls from clients asking about one subject, Rights Issues. Right issue this Right issue that, I almost lost my marbles but I know for sure that Muhammed our “Corporate Actions champion” will not be the same man again. He has been wearing the same clothes all week I guess he has not been home to see his wife and daughter as the Rights issues come thick and fast.
I am going to take you through a Right’s issue and hopefully shed some light on what it means to you the shareholder. In the last few weeks we have had Lonmin, Stellar Capital Partners and Advtech issuing Rights issues to the existing shareholders. Companies issues rights to their shareholders for various reasons. A rights issue is simply a request by a company for more cash from their shareholders for either expansion, acquisition or simply to better their balance sheet.
What is a rights issue?
Well firstly you do not have to toi toi in the streets when a company issues a rights issue or have to attend a Human rights concert featuring global stars like Bruce Springsteen, Tracy Chapman and Sting.
A rights issue is an invitation to existing shareholders to buy additional shares in the company at a discount to the market price. Hold on why do I need an invitation? Well this party is not for all, this party is only for shareholders who are holding the shares at a particular date, the Last day to trade Cum rights (LDT). This corporate action gives existing shareholders a tradeable instrument called a right, let me explain. The right is the privilege or claim a shareholder has on their discounted shares. If you do not have the rights or claim to the discounted shares no discounted shares for you.
The rights issue is dilutionary in nature and shareholders are compensated for this by the company. The rights that you are given have a value to them and can be traded between the time of the issue and the day when the new shares start trading.
How does it all work?
The simplest way to explain this phenomenon is by using a current market example. I have pulled Lonmin out of the “hat”. Click here for the details of the rights issue. I will make reference to the document later on and would be great if you can open it to follow my thoughts.
Let’s say I owned 1000 shares of Lonmin PLC pre the rights issue at 374c. The company has highlighted that they need to raise cash to the tune of $407 million to shore up their balance sheet. Lonmin have announced a rights offering where 26,997,717,400 shares at a price of 1 pence or ZAr 0.214 (this is called the subscription price). The issue is for 46 new shares for every 1 existing share, which translates to 46,000 rights.
So where has my money gone??
Waking up from my slumber on the morning of the Ex rights date (date where shares being traded on the market cannot participate in rights issues), I realise that my account has been depleted my 1000 Lonmin shares are worth R290. Those slimy brokers are at it again, only to realise that the share is now trading ex rights and the market is now factoring in the issue of the 26,997,717,400 new shares. Ok but where is my money Paul? Well my money is now in two instruments firstly the 1000 shares that I am holding at the new market price and the company compensates me for the dilutionary effect by giving me 46,000 as above.
Ok let’s put it simply. I have a business that I own with my brother Geoffrey (real name) called Chakaduka and Chakaduka how simple can it get. We have equal shareholding in the business and the business is worth R100, 000. We have a total of 1000 shares in issue. From simple maths the shares are valued at, NO calculators please…. R100. We decided to issue 500 new shares at R90 raising R45, 000. It’s a simple rights issue it will be a 2 for 1 rights issue. So for every share 2 shares I own I will get 1 right. Geoffrey decides not to take up his rights (Geoffrey sells me his rights) and I take up the full 500 new shares. The business is now worth R100000+ 45000=145000. However our shares are not worth R100 any more they are now worth R96.67. By not taking up his rights Geoffrey’s shareholding is still worth R50, 000 (34.5%) and I have bumped up my shareholding to R95000 (65.5%). The simple example shows how the Chakaduka and Chakaduka’s rights issue has had a dilutionary effect on Geoffrey’s shareholding.
So let’s come back to the Lonmin example, and let’s look at the options that are presented to me.
What options do I have?
I have three options I can take
Take up the rights to purchase in full (as I did in the Chakaduka and Chakaduka rights issue), I would need to spend ZAr 0.214 per share.
Paul Chakaduka’s Position Pre-rights issue =1000 @374c
Nil paid Rights issued to Paul Chakaduka= 1000*46= 46000
I will have to put up an additional R9844 on subscription date to take up my shares, I have derived this as follows:
Nil paid rights x subscription price= 46000x 0.214= 9844.
At the end of the rights issue my shareholding will look as follows (I have assumed that the share price will correct down to the rights price of ZAr 0.214 for illustration purposes)
Paul Chakaduka’s Lonmin Position
47000 shares (1000+46000 shares) @0.214= 10058
So if I want to take up my rights I need to respond to the invitation (no gate crashers will be welcome) from my broker. Like any good party the host needs to know how many people (s)he has to cater for and like such the broker and ultimately the company would like to know who is taking up their rights. When I have responded to the invitation, I need to be aware of the salient dates on the corporate action notice. My account needs to be funded ahead of the take up date (see page 26 of the Lonmin rights, issue link above)
I can let the right’s lapse
Being the kind of guy that I am, I normally do not have R9844 floating around. So one may not be able to afford to take up the rights. If you do not take up your rights you run the risk of having your shareholding diluted. One needs to look closely at the rights issue, its purpose and then decided to participate or not. In recent times we have seen some rights issues that have not yielded any positive results for the shareholder or the business. So do some research and see if it is worth while taking up the rights.
I can sell the rights to other investors (As Geoffrey did in Chakaduka and Chakaduka rights issue)
The nil paid rights are tradeable securities which a holder can sell to other shareholders. As Geoffrey did above, he sold me his rights. I can do the same with my Lonmin Rights, The nil paids are listed with a ric code of LONN.
Ok so I am going to be on my merry way, if there is something to remember from this little note is:
1) Rights give you a claim to buy a discounted share
2) Rights Issues are dilutionary
3) Not all rights issue are worth the paper there are written on
4) If you take up your rights you will need to put up some more cash to take up the shares
5) Do some research and understand what you are doing. If you do not stop pick up the phone and call someone who might have an idea before you get your hands burnt.
Remember if you are holding Lonmin rights you can exercise these rights into Lonmin ordinary shares. The last day to give us instructions to take up these rights is Tuesday 08 December 2015. You can do so by emailing our corporate actions team on firstname.lastname@example.org