What it means
In a rights issue, a company offers existing shareholders the chance to buy extra shares, usually at a discount to the market price. Each shareholder receives rights in proportion to their holding, such as one right for every share.
If the rights are renounceable, the shareholder can take up the offer, sell the rights on the market, or let them lapse. The ability to sell matters because a rights issue usually pushes the share price down.
New shares are issued at a discount and the number of shares rises, so each share is worth a little less. Selling the rights lets shareholders who do not wish to invest more recover value for the dilution they suffer.
Rights have a market value of their own, usually traded for a short period on the stock exchange. Their price depends on the gap between the market price of the share and the discounted subscription price.
Shareholders should compare the choices carefully, because letting renounceable rights simply lapse gives away value. Non-renounceable rights, by contrast, cannot be sold.
A shareholder who does not take them up loses the value, which makes them less fair to those who cannot or will not invest. Renounceable offers are usually seen as the better option for shareholders, and some markets and exchanges expect them for large offers.
For a finance team planning a capital raise, renounceable rights widen participation and tend to be received more favourably by investors. The trade-off is that they require more administration and the trading of rights can add to price volatility.
The terms must be explained clearly so shareholders know the dates and choices.
In practice
Real-world examples.
Example
A mid-sized manufacturer needs $50,000,000 to buy a competitor and offers renounceable rights to its shareholders. A retired investor who does not want to put in more money sells her rights on the exchange and receives cash. Her shareholding is smaller as a percentage, but she is compensated for the dilution.
Example
A pension fund holds shares in a property company that announces a renounceable rights issue. The fund believes the company's plans are sound and uses all its rights to buy new shares at the discount. This keeps its ownership percentage the same.
Example
A private investor goes on holiday and forgets about a rights offer. Because the rights are renounceable, her broker automatically sells them for her on the last trading day, according to the standing instruction. She receives the proceeds instead of losing the value.
Formula
Calculation
Theoretical ex-rights price = (Existing shares x Market price + New shares x Subscription price) / (Existing shares + New shares)
Value of one right = (Theoretical ex-rights price - Subscription price) / Rights needed per new share
Suppose a company offers a 1-for-4 rights issue at $8, and the shares trade at $10. For every 4 existing shares, one new share is offered. Theoretical ex-rights price = (4 x 10 + 1 x 8) / 5 = 48 / 5 = $9.60. Value of the new share's right = 9.60 - 8 = $1.60, so each right is worth 1.60 / 4 = $0.40. A holder of 4 shares worth $40 ends with shares worth 4 x 9.60 = $38.40 plus $1.60 from selling the rights, which is $40 in total.Case study
Seen in the real world.
Stonecrest Holdings is an illustrative, fictional listed company that needed $30,000,000 to reduce its debt. Its advisers recommended a renounceable rights issue of 1 new share for every 5 held, priced at a 20% discount to the market price.
During the offer period, the rights traded on the exchange at around $0.25. About 70% of shareholders took up their rights, and most of the remainder sold theirs to investors who wanted the shares.
The offer was fully subscribed and the company reached its target. The illustrative lesson was that making rights tradable helped even the shareholders who did not want to invest, and it reduced resistance to the raise.
Watch out
Common mistakes.
- Letting renounceable rights lapse, which gives away value that could have been realised by selling them.
- Assuming the share price will stay at its old level after a rights issue, when it normally adjusts to the theoretical ex-rights price.
- Confusing renounceable rights with non-renounceable rights, which cannot be traded and expire worthless if not used.
Questions
People also ask.
What does renounce mean here?
To renounce a right is to give it up or transfer it to someone else, which in a rights issue means selling it.
Do I have to buy the new shares?
No, you can take up the offer, sell the rights, or do nothing, although doing nothing usually wastes their value.
Why do companies offer a discount?
The discount encourages shareholders to take up the offer, and it makes sure the issue succeeds even if the share price moves during the offer period.
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