Here are some basic things you need to know before you apply to the rights issue by the company where you are holding shares:

A rights issue is a fresh issue of shares to the existing shareholders of the company. Normally, if the rights are issued at around the CMP, then existing shareholders may not be too interested. Hence companies normally issue rights shares at a fair discount to the CMP so that existing shareholders see value in them.

When a company comes out with a rights issue it necessarily leads to dilution of equity of the stock and therefore the EPS and the ROE will reduce. Here is how…

Details

Pre Rights Issue

Details

Post Rights Issue

Number of shares O/S

10,000 shares

Number of shares

15,000 shares

Net profits for 2017-18

Rs.3,70,000

Net profits for 2017-18

Rs.3,70,000

EPS

Rs.37 per share

EPS

Rs.24.67 per share

Rights issue

1:2

As can be seen from the above table the rights issue does lead to dilution of the equity and therefore the EPS of the company falls since the profits are constant.

Rights are offered to only those shareholders whose names exist on the register of shareholders of the company on the record date. That is the cut-off date for issue of rights shares. 2 days prior to that will be the Ex-Rights date. So, if the record date for the rights issue is 25th February then the ex-rights date will be 23rd February. Any purchase to qualify for the rights will have to be made by 22nd February. If there are any non-trading days in between then the ex-rights date will be pushed back accordingly.

Rights are an option which you may or may not exercise. If you exercise the rights offer you have to pay the amount towards subscription based on the rights price and the number of shares eligible. You also have the right to forfeit the rights issue if you are not interested in adding more shares of the same company.

Since rights represent a privilege or the right of first refusal to the existing shareholders, this right has a value. It would be of interest to understand how the value of this right is calculated. Check out the table below…

Particulars

Amount

Number of shares held by Investor X

1000 shares

Market price of the share before rights

Rs.180 (A)

Value of the Investment

Rs.180,000

Rights Issue ratio

1:2

Rights issue price

Rs.100

Number of rights shares

500 shares

Value of Rights Shares

Rs.50,000

Total value of shares post rights

Rs.2,30,000

No. of shares post rights

1500 shares

New cost of shares

Rs.153.33 (B)

Value of the Right = (A-B) = (180-153.33)

Rs.26.67 per share

Rights are traded in the market with a unique ISIN number on the exchanges. The basis for pricing the right is the value of the right which is Rs.26.67 per share. As a shareholder, you have the right to either subscribe to the shares or even sell the rights in the market under their unique ISIN. You will be approximately value neutral if you opt to subscribe for the shares or if you choose to sell the rights in the market.

Many investors tend to confuse a rights issue with a bonus issue. They are entirely different. Bonus issues are largely value neutral. What happens in a bonus is that you transfer money from the free reserves to the share capital. Hence the ROE and the EPS remains the same. In case of rights you are actually paying money to buy additional shares, even it is at a discount.

The rights price is normally expressed as a premium over the par value of the stock. For example, Piramal Enterprises announced its rights issue in the ratio of 1:23 on 12th December 2017 at a premium of Rs.2378. Since the current par value of the stock is Rs.2, this means the rights issue was at Rs.2380/share. That was still a huge discount to the market price of the stock.

The moral of the rights story is that, rights offer a very well established method of raising funds from existing shareholders. As an investor you need to understand the above nuances.