A Rights Issue is fast becoming a usual terminology in the capital markets of Uganda. Both individual and institutional investors have had a taste of Rights Issues when Uganda Clays became the first company to offer Rights to existing shareholders. Today we explore how a shareholder should approach an offer and the possible implications of their actions.
An appropriate starting point is defining a Rights Issues so that we can take off from the same platform. A Rights Issue is an issue of new shares for cash to existing shareholders in proportion to their existing holdings at a discounted price (usually 20 to 30 percent of the market price). Therefore, it is a way of raising new cash from shareholders – an important source of new equity funding for publicly quoted companies. It is important to note that it is an offer of new shares for cash and this offer is only made to existing shareholders. There are other offers for new shares that may be offered to existing shareholders, but not for cash; these are defined differently. What is the implication of this?
The first important implication to a shareholder is that one will need to pay cash in order to acquire the new shares being offered. As a shareholder you have to be able to pay for these shares and thus you need to have money for this. The amount of money you pay depends on the number of shares one is entitled to. The entitlement is calculated based on one’s level of shareholding at the cut off date.
Another important implication is that Rights are offered to existing shareholders only. This is because existing shareholders have the “right of first refusal” (commonly known as pre-emption rights) on the new shares. By taking these pre-emption rights up, existing shareholders can maintain their existing percentage holding in the company. Does this mean those who do not own shares in that particular company cannot participate at all?
No. Shareholders can, and often do, waive these rights, by selling them to others. Shareholders can also vote to rescind their preemption rights. Existing shareholders, who are entitled to exercise their rights, may exercise their rights in one of two ways.
They may choose to buy their rights at the offer price or renounce their rights and sell them to the market. It is when these existing shareholders sell to the market that any one can buy these shares. However, it is important to note that these shares will be sold at a market determined price and not the rights offer price.
When a Rights Issue is announced dates are set to inform existing and prospective shareholders. There are three key terms.
Book closure date. This is the date when the shareholder register is closed. This means that the rights offer/issue will only be applicable for shareholders who are recorded in the register as at the closure date.
Offer period. This is the period within which rights are offered to the existing shareholders.
Offer ratio. Shares are normally issues in ratios. For instance, three shares for every five shares held. This would mean that for someone who holds 500 shares, they would benefit 300 additional shares.
Let us say for argument sake that one buys five shares trading at UGX3,000 and this rights are being offered at a 30 percent discount.
The ratio is three new shares for every five held
|
5 existing shares at a market price of UGX3,000 |
15,000 |
|
3 new shares at a market price of UGX2,100 |
6,300 |
|
Total for 8 shares |
21,300 |
|
Value of 1 share post rights issue |
21,300/8 |
|
Effective cost per share |
2,662.50 |
The difference between the market price per share of UGX3,000 and the effective cost per share of UGX2,6662.50 is your profit. The post rights issue price cannot be determined as situations differ but the principle holds true. Therefore, it is advisable to follow your rights and take advantage of the fact the shares are being offered below the market price but it is not mandatory.
At this point, I find it relevant to explore the possible direction of a share price post a Rights Issue and the reasons thereof. The share price is usually expected to fall after the Rights Issue. This is not necessarily the case although it is very common.
The share price may fall not because the market’s views about the company have changed but merely because the market is absorbing the new shares just issued. Since the number of shares will have increased in some instances by a huge percentage, the price would need to be adjusted to match the new number of shares. However in some cases the post rights issue price has actually gone up. This could be a result of many reasons.
Whichever direction the post Rights Issue takes it is important for investors to pay attention to the fundamental features of any stock. One has to be satisfied that the company’s growth potential is significant, the cash flows are healthy and that the business will continue to be profitable and deliver value to shareholders. Investment advisors and stockbrokers can be useful in explaining these issues and assist would-be investors.
It is very important to avoid being carried away by following what others are doing. Fundamental analysis is very important and should be an important consideration before making any investment in shares.
Investors should treat any rights issue as a fresh equity issue, as they would be increasing their exposure to a company. Therefore, all necessary precautions of a fresh investment should be taken.
This is a slightly edited version; the article originally appeared in Uganda Securities Exchange Quarterly Bulletin.
Ms. Tambudzai Maswaya is the Operations Manager at ReNaissance Capital Limited.
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