Rights Issue (Rights Offering)

A Rights Issue (also known as a Rights Offering) is an invitation from a company to its existing shareholders to purchase additional new shares of the company. Think of it like a members-only sale. As a current owner, you get the exclusive “right” to buy these new shares, typically at a significant discount to the current market price. The company isn't just being generous; it's a specific method for raising fresh capital. This new money might be used for exciting growth projects like building a new factory, for shoring up the company's balance sheet by paying down debt, or sometimes, out of necessity, to stay afloat during difficult economic times. A rights issue is a direct appeal to a company's most loyal supporters—its current shareholders—asking them to increase their investment. For you, the investor, it’s a critical fork in the road that requires a decision.

A company's management chooses a rights issue over other forms of fundraising for several key reasons. Primarily, it's a way to raise money while prioritizing existing owners. This can foster goodwill and reward shareholder loyalty. From a practical standpoint, it's often faster and less expensive than a full-blown secondary offering to the general public. The company is marketing to a concentrated, known audience (its shareholder register) rather than the entire investment world, which reduces marketing costs and administrative hurdles. In some cases, a company might be in a situation where its credit is poor or market conditions are shaky, making a rights issue one of the few viable ways to secure funding. An underwriter, typically an investment bank, may guarantee to purchase any unsubscribed shares, ensuring the company successfully raises the full amount of capital it needs.

The process might sound complex, but it boils down to a few key stages and one big decision for you.

The company’s board of directors will officially announce the rights issue, laying out all the important details:

• The Ratio: This tells you how many new shares you can buy for the shares you already hold. For example, a “1-for-5” rights issue means you can buy one new share for every five shares you currently own.
• The Subscription Price: This is the special discounted price at which you can buy the new shares.
• The Timeline: The announcement will include critical dates, such as the record date (when you must own the stock to be eligible) and the expiration date (the deadline for making your decision).

Once you receive your rights, you have a decision to make. These rights are temporary securities that have real value, so choosing wisely is crucial.

1. Exercise Your Rights: You can accept the offer, pay the company the subscription price for your new shares, and increase your holding in the company. By doing this, you prevent your ownership stake from being diluted.
2. Sell Your Rights: If you don't want to buy more shares but still want to extract value, you can often sell your rights on the open market. Other investors will buy them from you to gain access to the discounted shares. You'll receive cash, but your percentage ownership in the company will decrease.
3. Let Your Rights Expire: You can do nothing. When the offer period ends, your rights become worthless. This is almost always the worst option. Your ownership stake is subject to dilution, and you receive no compensation for the value of the rights you let disappear.

A rights issue should immediately trigger your analytical instincts. It is neither inherently good nor bad; its merit depends entirely on the context.

The most important question is: Why does the company need the money?

• Opportunity: If a well-managed company with a strong business model is raising capital to fund a high-return project or make a strategic acquisition, participating in a rights issue can be a fantastic opportunity. It allows you to increase your stake in a great business at an attractive price, essentially doubling down on a winning horse. Legendary investors like Warren Buffett have made fortunes by participating in rights issues for fundamentally sound companies like American Express and Bank of America when they needed capital.
• Red Flag: Conversely, if a struggling company is issuing rights simply to plug holes in a leaky balance sheet or fund ongoing losses, it's a major red flag. This is often called a “di-worsification,” where the company is throwing good money after bad. In this case, you may be better off selling your rights and reducing your exposure.

The discount on a rights issue isn't free money. It's a mathematical adjustment to compensate existing shareholders for the dilution that is about to occur. To understand this, you need to know about the Theoretical Ex-Rights Price (TERP). This is what the share price should theoretically fall to after the new shares are issued. Let's see it in action: Imagine a company, “ValueCo,” has 1 million shares outstanding, trading at €10 per share. Its market capitalization is €10 million.

1. ValueCo announces a 1-for-4 rights issue at a subscription price of €7.
2. This means it will issue 250,000 new shares (1,000,000 / 4).
3. The company will raise €1.75 million in new capital (250,000 shares x €7).

Now, let's calculate the Theoretical Ex-Rights Price (TERP):

1. Total Value of Company Post-Issue: (€10m from old shares) + (€1.75m in new capital) = €11.75 million
2. Total Shares Post-Issue: (1,000,000 old shares) + (250,000 new shares) = 1,250,000 shares
3. TERP: €11,750,000 / 1,250,000 shares = €9.40 per share

As you can see, the market price will theoretically drop from €10 to €9.40. If you exercise your rights and buy the new shares at €7, the discount helps offset this price drop. If you do nothing, your existing shares just fall in value, and you've lost the value of your rights.

• A rights issue is a call to action. It forces a decision about your conviction in the company.
• The reason for the capital raise is paramount. Is it for smart growth (an opportunity) or to cover up problems (a red flag)?
• The subscription “discount” is not a free lunch. It's a mechanism to allow you to maintain your proportional ownership value in the face of dilution.
• Doing nothing is usually the worst financial move. You suffer the full effect of dilution without receiving any cash compensation from selling your valuable rights.