Rights Issue
What is a “Rights Issue”?
Issuing equity and raising debt are the two primary methods used by companies to raise capital. A rights issue involves raising capital by issuing equity shares, which are offered only to the existing shareholders of the company and not to the general public. In simple terms, a rights issue is an offering of rights only to the existing shareholder of a company to purchase additional shares at a discounted price and these rights are available for a short period (usually 30 days).
Typically there are two types of rights issues: renounceable (transferable) and non-renounceable (not-transferable). If the rights are renounceable, existing shareholders can sell their rights to additional shares onto other investors. Whereas, in the case of non-renounceable rights issues, existing shareholders cannot sell rights to anyone so simply have the option to either buy the additional shares or turn the rights issue offer down.
Key Learning Points
- Rights issues are an offer to existing shareholders of a company to buy more shares (typically at a discounted price) to raise capital
- Rights issues are not an obligation for existing
- Rights issues result in the dilution of existing shares as new shares have been issued
- The market price of a stock after a rights issue is known as Theoretical ex-rights Price (TERP)
- If an existing shareholder chooses to sell the rights, this is described as ‘nil paid’ because the shareholder has not paid for these rights
Rights issue – Salient Features
Not an obligation
A rights issue gives existing shareholders of a company the ‘right’ to purchase additional shares. However it is not an obligation as they can choose to opt in for the rights issue, allow their rights to expire or possibly sell their rights to other investors.
Dilution of shares
A rights issue results in the dilution of existing shares and consequently earnings per share (EPS). Post the rights issue, the company’s net profit will have to be distributed amongst a higher number of shares. This dilution in earnings per share (EPS) causes a drop in a company’s share prices after a rights issue. The percentage of the fall depends entirely on the market.
Theoretical Ex-Rights Price (TERP)
Theoretical Ex-Rights Price (TERP) is the market price of a stock after a rights offering. A simple way to estimate the TERP is by adding the market value of shares before the rights issue to the money raised from the rights issue. This total is then divided by the total number of shares after the rights issue to obtain the TERP.
The TERP can be calculated after the last day of a right’s offering. It can also be estimated during the rights offer period, based on assumptions of the number of shareholders opting for the rights issue.
Nil-paid rights
If an existing shareholder does not want to purchase any new or additional shares of the company and instead of letting the rights lapse prior to the predetermined date, he or she may be able to sell or trade the same. If this is done, then the existing shareholder is selling the rights ‘nil paid,’ as he or she has not paid anything for these rights.
The nil-paid rights can be calculated as TERP less the rights issue price. Nil-paid rights are the profit that is available or the gain to shareholders from purchasing shares at the rights issue price.
Example: Calculating the TERP & Nil-paid rights
Suppose a company offers 1:2 rights issues to its shareholders. This means that existing shareholders can purchase 1 additional share for every two shares held by them.
Having stated the above, the TERP and Nil-paid rights (assuming all shareholders opt for the rights issue) have been calculated below, based on the following information
| Number of outstanding shares | 1,000 | |
| Existing share price | 3.0 | |
| Discounted share price (rights issue) | 2.0 | |
| Theoretical ex-rights price (TERP) | ||
| Equity value before the rights issue | 3,000 | =C7*C8 |
| New shares issued after the rights issue (assuming 100% shareholders opt for the rights issue) | 500 | |
| Funds expected to be raised through the rights issue | 1,000 | =C13*C9 |
| Total equity value | 4,000 | =C12+C14 |
| Total number of shares after the rights issue | 1,500 | =C13+C7 |
| Theoretical ex-rights price | 2.7 | =C15/C16 |
| Nil-paid rights | 0.7 | =C17-C9 |
Rights issue in practice
In October 2020, Rolls-Royce Holdings Plc launched a rights issue to raise additional funds. Given below is an excerpt from the news announcement.
This rights issue gives existing shareholders an option to purchase the company’s shares at a 75% discount below the company’s last traded price. It is offering 10 new shares for three existing shares. Further, the company has also stated its TERP at the time of launching the rights issue.