Recapitalisation: Rights Issue to The Rescue


By Eromosele Abiodun, 06.22.2010


When the secondary market of the Nigerian Stock Exchange (NSE) was very attractive, companies (mostly banks), which raised money during government-induced consolidation in the financial sector preferred apportioning a higher percentage of their shares on offer to new shareholders probably because most of them were coming to the market for the first time.



Precisely, 36 banks raised over N506.6 billion on the stock market between July 2004 and December 2005 – the 18 months period in which banks were required to raise their capital to a minimum of N25 billion from N2billon.But recently, after the special joint audit carried out by the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) in the banking industry, some banks were asked to raise fresh capital aimed at meeting the CBN 10 per cent capital adequacy ratio and ensuring long-term sustainability of their operations.



In a bid to raise the required funds, most of the banks have opted to offer shares to existing shareholders (Rights Issue), a situation that may not have been possible few years ago. Analysts believe these banks are adopting the Right Issue option because of the lull in the market.
They said that new offerings made to fresh investors may not sell because promises made by most companies during their last adventure were not kept.



Some analysts also contended that creating new shares will increase the number of new shareholders, which means the companies offering new shares have to work extra hard to ensure improved dividend payout.Besides, analysts said that shareholders would be the losers, as those who do not exercise their rights by buying the discounted shares on offer will lose money, as their existing holdings will suffer from the dilution.



Another important factor to note, according to operators,  is that even when new investors do not want to buy into a company, existing shareholders do not have a choice. Reason being that if a company is cash strapped and there is urgent need for it to raise money, existing shareholders must bail out their company or  be ready to lose their entire investments. Another reason why companies embrace Rights Issue is that some companies with clean balance sheets use them to fund acquisitions and growth strategies.



However, given the fact that most investors do not understand the concept of Rights Issue, many problems have occurred in recent times. An example was the Oando Plc and Cadbury Nigeria Plc Rights Issue where a good number of investors lost a fortune by failing to trade the rights they were unable to take up.



Meaning of Rights Issue   


A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. This type of issue gives existing shareholders securities called “rights”, which will give the shareholders the right to purchase new shares at a discount to the market price on a stated future date.



The company is giving shareholders a chance to increase their exposure to the stock at a discount price.But until the date at which the new shares can be purchased, shareholders may trade the rights on the market the same way they would trade ordinary shares. The rights issued to a shareholder have a value, thus compensating current shareholders for the future dilution of their existing shares’ value.



Managing Director and Chief Executive Officer of Emerging Capital Limited, Mr. Chidi Agbapu, in a chat with THISDAY, said a right is an offer issued by a company to shareholders to purchase more shares of its shares (usually at a discount).  Rights, he said, have a value and can be traded. “Stockholders that have received renounceable rights have three choices of what to do with the rights. They can act on the rights and buy more shares as per the particulars of the rights issue; they can sell them on the market; or they can pass it on taking advantage of their rights,” he said.



He explained: “Cash-strapped companies can turn to Rights Issues to raise money when they really need it. In these rights offerings, companies grant shareholders a chance to buy new shares at a discount to the current trading price. Troubled companies typically use rights issues to pay down debt, especially when they are unable to borrow more money. But not all companies that pursue rights offerings are shaky. For reassurance that it will raise the finances, a company will usually, but not always, have its rights issue underwritten by an investment bank.”



How Rights Issues Work


On how the concept of rights issue work, Agbapu said: “The best way to explain is that it is better than bank borrowing, which may impact on earnings of quoted companies.“For example, if you own 1,000 ordinary shares in a telecommunication company, each of which is worth N5.50. The company is in a bit of financial trouble and urgently needs to raise cash to cover its debt obligations. The company would announce a Rights  Issue, in which it plans to raise N30 million by issuing 10 million ordinary shares to existing investors at a price of N3.00 each. But this issue is a three-for-ten rights issue. In other words, for every 10 shares you hold, the company is offering you another three at a discounted price of N3.00 This price is 45 per cent less than the N5.50 price at which the company’s stock trades.



“As a shareholder, you essentially have three options when considering what to do in response to the rights issue. You can (1) subscribe to the rights issue in full, (2) ignore your rights or (3) sell the rights to someone else.”



Taking Up The Rights 


On his part, frontline stockbroker and market analyst, Mr. Idowu Ogedengbe, said that for shareholders to take advantage of their Rights Issue in full, they would need to spend some amount of money for every one of the company’s shares that they are entitled to, under an issue or offering. “If for example, you hold 1,000 ordinary shares in a company, you can buy up to 300 new shares (three shares for every 10 you already own) at a discounted price of N3, translates to a total price of N900.



“However, while the discount on the newly issued shares is 45 per cent, it will not be static. The market price of the company’s shares will not stagnate at N5.50 after the Rights Issue exercise is completed. The value of each share will be diluted because of the increased number of shares issued. To find out if the Rights Issue gives a material discount, you need to estimate how much of the company’s shares will be diluted. 



“In estimating this dilution, remember that you can never know the future value of your expanded holding of the shares, since it can be affected by any number of business and market factors. But the theoretical share price that will result after the Rights Issue is complete, which is the ex-rights share price.This is easire to calculate. This price is arrived at by dividing the total price you will have paid for all the company’s shares by the total number of shares you will own.” 


1,000 existing shares at      N5.50   N5,500

300 new shares for cash at N3 .00   N900

Value of 1,300 shares N6, 400

Ex-rights value per share  N4.92 (N6,400.00/1,300 shares)



In theory, as a result of the introduction of new shares at the deeply discounted price, the value of each of your existing shares will decline from N5.50 to N4.92. But remember, the loss on your existing shareholding is offset exactly by the gain in share value on the new rights: the new shares cost you N3, but they have a market value of N4.92. These new shares are taxed in the same year as you purchased the original shares, and carried forward to count as investment income, but there is no interest or other tax penalties charged on this carried-forward, taxable investment income,” he said.



Can Rights Issue Be Ignored?


Ogedengbe said: ”You may not have the N900 to purchase the additional 300 shares at N3 each, so you can always let your rights expire. But this is not normally recommended. If you choose to do nothing, your shareholding will be diluted – thanks to the extra shares issued and you will also lose money if you fail to trade your right,”



Selling Your Rights 


Sunday Ojo of Independent Securities Limited, believes investors’ rights are not transferable in some cases. He said: “These are known as “non-renounceable rights”. But in most cases, your rights allow you to decide whether you want to take up the option to buy the shares or sell your rights to other investors or to the underwriter. 



“Rights that can be traded are called ‘renounceable rights’, and after they have been traded, the rights are known as ‘nil-paid rights’.  To determine how much you may gain by selling the rights, you need to estimate a value on the nil-paid rights ahead of time. Again, a precise number is difficult, but you can get a rough value by taking the value of ex-rights price and subtracting the Rights Issue price. So, at the adjusted ex-rights price of N4.92 less N3, your nil-paid rights are worth N1.92 per share. Selling these rights will create a capital gain for you.”



Renounceable and Non-Renounceable Rights


A non-renounceable right, according Mr Ojo, is an offer issued by a company to its shareholders to purchase more shares of the corporation (usually at a discount). “Unlike a renounceable right, a non-renounceable right is not transferable, and therefore cannot be bought or sold. Issuing more shares dilutes the value of outstanding stock. But because the rights issue allows the existing shareholders to buy the newly issued stock at a discount, they are compensated for the impending share dilution. The compensation the rights issue gives them is equivalent to the cost of share dilution,” he explained. 



Renounceable on the other hand, is an offer issued by a quoted company to its shareholders to purchase more shares of the corporation’s stock (usually at a discount). Renounceable rights, he stressed, have a value and can be traded.Shareholders that have received renounceable rights have three choices of what to do with the rights. They can act on the rights and buy more shares as per the particulars of the rights issue; they can sell them in the market; or can pass on take advantage of their rights,” he explained.



Be Warned


However, Ojo warned that shareholders should not be tempted by the prospect of buying discounted shares with a Rights Issue.“It is very easy for investors to get tempted by the prospect of buying discounted shares with a rights issue. But it is not always a certainty that you are getting a bargain. Besides knowing the ex-rights share price, you need to know the purpose of the additional funding before accepting or rejecting a Rights Issue. 



Be sure to look for a compelling explanation of why the Rights Issue and share dilution are needed as part of the recovery plan. Sure, a Rights Issue can offer a quick fix for a troubled balance sheet, but that does not necessarily mean management will address the underlying problems that weakened the balance sheet in the first place. Shareholders should be cautious,” he stressed.





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