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4 Things You Need to Know About Rights Issue


Dear Members,

I received another question from my subscriber. The question is as follows:


‘Hong Leong Bank Bhd had undertaken Rights Issues on December 2015. How would Rights Issue affect the Earnings per Share (EPS) of the company?’

Here, I would attempt to answer this question. If you are new to stock investing, the mechanics behind Rights Issue can be quite overwhelming.

Hence, the answer would be written in 2 separate reports. For this issue, the focus is on explaining what ‘Rights Issue’ is and how it might affect retail investors like you and me. We would reveal and discuss the answer to the question above in a case study


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Basically, there are 4 things we need to know for ‘Rights Issue’. They include:

 

#1: What is Rights Issue?

 

Let us start of with ‘Rights’. The ‘Rights’ refer to the existing shareholders of the company. They have already bought shares of the company. In this case, the ‘Rights’ are directed to shareholders of Hong Leong Bank Bhd. Now, we talked about ‘Issue’. This refers to issuance of new shares. If you put the two words together, it simply means the issuance of new shares to existing shareholders of the company.



Rights Issue =

Issuance of New Shares to Existing Shareholders

at Discounted Prices



Often, the shares are issued at a discount to its current market price. Hence, the discount is only applicable to existing shareholders, hence, the word ‘Rights’. It is an opportunity for existing shareholders to buy new shares of the company at a discount. This would allow them to maintain the proportion of shareholdings within the company.

 

#2: Why Stocks Undertake Rights Issue?


In general, there are 3 reasons why stocks may undertake rights issue. They include:



1 - Fund Expansions


This refers to stocks that have identified specific expansion plans to grow but lack the resources to finance them. To name a few, these expansion plans may include:



Within the Business

Beyond the Business

Construct New Factories

Buy Investment Properties

Buy Advanced Machineries

Subsidiaries & Associates Co.

Open New Outlets

Form Joint Ventures

Expand Overseas

New Property Development Project

Other Working Capital

Buy Oil Palm Plantation Estates



2 - Capital Restructuring


This refers to stocks that may be highly-geared. In other words, they have high levels of debt in proportion to their shareholders’ equity. Hence, they would undertake rights issue to pay off and lower the company’s debt-to-equity ratio. This would strengthen the company’s balance sheet and also reduces its finance cost in the future. Often, stocks that are unable to borrow money may employ Rights Issue as an alternative method of financing. This may be due to having poor credit as a result of shaky financial standings by the company.

 

3 - Higher Chance of Take-Up

Rights issue is often used as a faster method to raise cash. This is because the shares are issued at a discount to its current market price. Hence, this could attract higher take-up for new shares by existing shareholders as compared to selling shares to new potential investors at current market prices.

 

#3: The Impact to Existing Shareholders


This involves some calculation.


1 - Before Rights Issue


Let us assume that you are a shareholder of ABC Bhd. Before Rights Issue, you own 1,000 ABC Bhd’s shares which are worth RM 5.50 each. Hence, your current investment in ABC Bhd is worth RM 5,500.



2 - The Deal


Then, ABC Bhd announced that it is undertaking Rights Issue exercise. It is issued on the basis of 3 Rights Shares for every 10 Existing Shares held by existing shareholders. The offer price is RM 3.00 per share.

 

3 - What Can You Buy?


With the announcement, you are entitled to buy 300 shares at RM 3.00 per share. This is calculated:

 

You Can Buy

= Current Shareholdings x 3 Rights Shares / 10 Existing Shares

= 1,000 x 3 / 10

= 300 Shares



4 - Let’s Assume You Did


How many would you have now?


New Shareholdings = 1,000 + 300 = 1,300 Shares



What’s the theoretical value of your investment in ABC Bhd?


New Value

= RM 5,500 + (RM 3.00 x 300 Shares)

= RM 5,500 + RM 900

= RM 6,400



Why is it called ‘Theoretical’ value?


This is because share price of ABC Bhd may fluctuate and change after the Rights Issue. Hence, the results of this calculation would be ‘in-theory’ and be treated as a guide. What’s the theoretical value of one share of ABC Bhd?



New Value of One Share

= RM 6,400 / 1,300 shares

= RM 4.923 / share

 

Why the Theoretical Value is lower than RM 5.50 (current market price before Rights Issue)? This is because ABC Bhd would have increased its number of shares issued by 30%. Hence, this would dilute the existing value of each shares of ABC Bhd.


Does it mean that I’ve incurred a loss?


Not necessary.


This is because the loss incurred from the value diluted of your existing shareholdings is compensated by the gain from purchasing new shares at a discount. Allow me to illustrate:

 

Value Loss from Dilution

= (New Theoretical Value - Market Price Before Rights Issue) x No. of Existing Shares

= (RM 4.923 - RM 5.50) x 1,000 shares

= - RM 577



Gain from New Discount Shares

= (New Theoretical Value - Offer Price of Rights Shares) x No. of New Shares Bought

= (RM 4.923 - RM 3.00) X 300 shares

= RM 577



Hence, you did not lose a single cent by acquiring new shares.


Your Total Loss

= Value Loss from Dilution + Gain from New Discount Shares

= - RM 577 + RM 577

= RM 0



5 - What If You Did Not Subscribed


Then, the value of your investment in ABC Bhd would shrink by RM 577, down from RM 5,500 to RM 4,923. Therefore, in most cases, it is more advisable to take-up the Rights Issue. However, once again, it depends whether you are willing to invest an additional RM 900 into ABC Bhd.



New Value if You Did Not Subscribed

= New Theoretical Value x Existing No. of Shares

= RM 4.923 x 1,000 shares

= RM 4,923

 

#4: How EPS would be Affected?


It depends on how well the management utilize the money raised from Rights Issue.

Let us assume:


Before Rights Issue, ABC Bhd has 100 Million shares issued. It makes RM 50 Million in annual earnings. Thus, ABC Bhd makes RM 0.50 in EPS (Earnings per Share)


After Rights Issue, ABC Bhd had increased its number of shares issued to 130 Million shares. ABC Bhd continues to make RM 50 Million in annual earnings.


New EPS

= RM 50 Million / 130 Million shares

= RM 0.385



Hence, there is a difference if you choose to subscribe the rights issue or choose to ignore it.



Rights Issue

Before

Subscribed

Do Not Subscribe

Annual Earnings

(RM Million)


50


50


50

EPS

0.50

0.385

0.385

Your Shareholdings

(No. of Shares)


1,000


1,300


1,000

Your Share

of Earnings (RM)


500

500

385




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Regards

Ian Tai

Creator of Bursaking.com.my

The No.1 Stock Data Fanatic in Malaysia


Disclaimer:

The strategies outlined in this article / report / written material is intended for education & illustration purposes. It is strictly not intended to be an investment advice & must not be relied upon as personal financial advice. If you need specific investment advices, please consult the relevant professional investment advisors.

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