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Understanding Rights Issues | Investopedia
Understanding Rights Issues By Ben McClure | Updated December 29, 2015 — 1:30 PM EST
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You May Also Like: Learn to trade stocks with virtual money before you risk your own... 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. Let's look at how rights issue work, and what they mean for all shareholders.
Defining a Rights Issue and Why It's Used
A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. More specifically, this type of issue gives existing shareholders securities called "rights "rights", ", which, well, 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. shares. The rights issued to a shareholder have a value, thus compensating current shareholders for the future dilution of their existing shares' value. 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. Some with clean balance sheets use them to fund acquisitions and growth strategies. For reassurance that it will raise the finances, a company will usually, but not always, have its rights issue underwritten by an investment bank. bank.
How Rights Issues Work
So, how do rights issues work? The best way to explain is through an example. Let's say you own 1,000 shares in Wobble Telecom, each of which is worth $5.50. The company is in a bit of financial trouble and sorely needs to raise cash to cover its debt obligations. Wobble therefore announces a rights offering, in which it plans to raise $30 million by issuing 10 million shares to existing investors at a price of $3 each. But this issue is a three-for-10 rights issue. In other words, for every 10 shares you hold, Wobble is offering you another three at a deeply discounted price of $3. Topics Reference Advisors Markets Simulator This price is 45% less than the $5.50 price at which Wobble stock trades. (For further reading, see Understanding Stock Splits.)
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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. Here we look how to pursue each option, and the possible outcomes.
Quick Ratio Sharpe Ratio
1. Take up the rights to purchase in full To take advantage of the rights issue in full, you would need to spend $3 for every Wobble share that you are entitled to under the issue. As you hold 1,000 shares, you can buy up to 300 new shares (three shares for every 10 you already own) at this discounted price of $3, giving a total price of $900. However, while the discount on the newly issued shares is 45%, it will not stay there. The market price of Wobble shares will not be able to stay at $5.50 after the rights issue is complete. The value of http://www.investopedia.com/articles/stocks/05/062905.asp
1/4
2/2/2017
Understanding Rights Issues | Investopedia
each share will be diluted as a result of the increased number of shares issued. To see if the rights issue does in fact give a material discount, you need to estimate how much Wobble's share price will be diluted. In estimating this dilution, that you can never know for certain 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 - is possible to calculate. This price is found by dividing the total price you will have paid for all your Wobble shares by the total number of shares you will own. This is calculated as follows: 1,000 existing shares at $5.50
$5,500
300 new shares for cash at $3 Value of 1,300 shares Ex-rights value per share
$900 $6,400 $4.92 ($6,400.00/1,300 shares)
So, 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 $5.50 to $4.92. But , the loss on your existing shareholding is offset exactly by the gain in share value on the new rights: the new shares cost you $3, but they have a market value of $4.92. These new shares are taxed in the same year as you purchased the original shares, and carried forward to count as investment income, income, but there is no interest or other tax penalties charged on this carried-forward, taxable investment income.
2. Ignore the rights issue You may not have the $900 to purchase the additional 300 shares at $3 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.
Trading Center
3 Sell your rights to other investors In some cases, rights are not transferable. These are known as "non-renounceable "non-renounceable rights". 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 underwriter.. Rights that can be traded are called "renounceable "renounceable rights", rights", and after they have been traded, the rights are known as "nil-paid rights".
Partner Links To determine how much you may gain by selling the rights, you need to estimate a value on the nilpaid 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 $4.92 less $3, your nil-paid rights are worth $1.92 per share. Selling these rights will create a capital gain for you.
Test your forex trading skills in our FX trading simulator Trade like a top hedge fund manager using technical analysis and double your wealth... Learn to trade stocks by investing $100,000 virtual dollars...
The Bottom Line
It is awfully easy for investors to get tempted by the prospect of buying discounted shares with a Topics thatReference Advisors Markets Simulatorthe rights issue. But it is not always a certainty you are getting a bargain. But besides knowing 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 Search news, tickers, 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 doesn't necessarily mean management will address the underlying problems that weakened the balance sheet in the first place. Shareholders should be cautious.
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Compete, Risk Free with $100,000 in Virtual Cash
Put your trading skills to the test with our free Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own capital.
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2/2/2017
Understanding Rights Issues | Investopedia
RELATED ARTICLES INVESTING
Stock Rights Issue Rights are offers that allow existing stockholders to buy additional shares at a predetermined price, for a set time period. Usually, the number of shares the investor can purchase are in proportion ...
INVESTING
How Does Dilution Work? Dilution refers to the reduction in the percentage equity ownership of a company due to additional equity being issued to other owners.
MANAGING WEALTH
Knowing Your Rights As A Shareholder We delve into common stock owners' privileges and how to be vigilant in monitoring a company.
INVESTING
What Are Corporate Actions? Be a savvy investor - learn how corporate actions affect you as a shareholder.
INVESTING
Getting The Real Earnings EPS helps investors analyze earnings in relation to changes in new-share capital.
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Reference
Advisors
Assess Shareholder Wealth With EPS
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Simulator
Find out if management is doing its job of creating profit for investors.
Search news, tickers,
Newsletters
INVESTING
The Dangers Of Share Dilution Investors need to be aware of the existence of dilutive securities and how they can affect existing shareholders.
INVESTING
The Basics Of Outstanding Shares And The Float We go over different types of shares and what investors need to know about them.
http://www.investopedia.com/articles/stocks/05/062905.asp
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2/2/2017
Understanding Rights Issues | Investopedia
INVESTING
How To Sell Put Options To Benefit In Any Market Selling a put option is a prudent way to generate additional portfolio income and gain exposure to desired stocks while limiting your capital investment.
RELATED FAQS Q: Why would a company issue a rights offering? Understand more about a rights offering, and learn the most common reasons a company might have to issue a rights offering, ... Read Answer >>
Q: What is a direct rights offering? Discover what a direct rights offering is, what it means for shareholders who receive the offering, and the reasons a company ... Read Answer >>
Q: Why is the value of capital stock important to public shareholders? Understand what capital stock is and how it's issued and authorized. Learn why the value of capital stock important to public ... Read Answer >>
Q: What are some characteristics of ordinary shares? Read about some of the primary characteristics of ordinary shares, also known as common shares, including voting rights and ... Read Answer >>
Q: Why is an increase in capital stock on a company's balance sheet a bad sign for stockholders? Understand what capital stock represents for a company and understand the significance for investors when a company initiates ... Read Answer >>
Search Investopedia
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Understanding Rights Issues | Investopedia
Understanding Rights Issues By Ben McClure | Updated December 29, 2015 — 1:30 PM EST
SHARE
You May Also Like: Learn to trade stocks with virtual money before you risk your own... 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. Let's look at how rights issue work, and what they mean for all shareholders.
Defining a Rights Issue and Why It's Used
A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. More specifically, this type of issue gives existing shareholders securities called "rights "rights", ", which, well, 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. shares. The rights issued to a shareholder have a value, thus compensating current shareholders for the future dilution of their existing shares' value. 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. Some with clean balance sheets use them to fund acquisitions and growth strategies. For reassurance that it will raise the finances, a company will usually, but not always, have its rights issue underwritten by an investment bank. bank.
How Rights Issues Work
So, how do rights issues work? The best way to explain is through an example. Let's say you own 1,000 shares in Wobble Telecom, each of which is worth $5.50. The company is in a bit of financial trouble and sorely needs to raise cash to cover its debt obligations. Wobble therefore announces a rights offering, in which it plans to raise $30 million by issuing 10 million shares to existing investors at a price of $3 each. But this issue is a three-for-10 rights issue. In other words, for every 10 shares you hold, Wobble is offering you another three at a deeply discounted price of $3. Topics Reference Advisors Markets Simulator This price is 45% less than the $5.50 price at which Wobble stock trades. (For further reading, see Understanding Stock Splits.)
HOT DEFINITIONS Dodd-Frank Wall Street Reform and Consumer Protection ... Portfolio Management Smart Home
Value Search news, tickers, Investing Newsletters
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. Here we look how to pursue each option, and the possible outcomes.
Quick Ratio Sharpe Ratio
1. Take up the rights to purchase in full To take advantage of the rights issue in full, you would need to spend $3 for every Wobble share that you are entitled to under the issue. As you hold 1,000 shares, you can buy up to 300 new shares (three shares for every 10 you already own) at this discounted price of $3, giving a total price of $900. However, while the discount on the newly issued shares is 45%, it will not stay there. The market price of Wobble shares will not be able to stay at $5.50 after the rights issue is complete. The value of http://www.investopedia.com/articles/stocks/05/062905.asp
1/4
2/2/2017
Understanding Rights Issues | Investopedia
each share will be diluted as a result of the increased number of shares issued. To see if the rights issue does in fact give a material discount, you need to estimate how much Wobble's share price will be diluted. In estimating this dilution, that you can never know for certain 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 - is possible to calculate. This price is found by dividing the total price you will have paid for all your Wobble shares by the total number of shares you will own. This is calculated as follows: 1,000 existing shares at $5.50
$5,500
300 new shares for cash at $3 Value of 1,300 shares Ex-rights value per share
$900 $6,400 $4.92 ($6,400.00/1,300 shares)
So, 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 $5.50 to $4.92. But , the loss on your existing shareholding is offset exactly by the gain in share value on the new rights: the new shares cost you $3, but they have a market value of $4.92. These new shares are taxed in the same year as you purchased the original shares, and carried forward to count as investment income, income, but there is no interest or other tax penalties charged on this carried-forward, taxable investment income.
2. Ignore the rights issue You may not have the $900 to purchase the additional 300 shares at $3 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.
Trading Center
3 Sell your rights to other investors In some cases, rights are not transferable. These are known as "non-renounceable "non-renounceable rights". 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 underwriter.. Rights that can be traded are called "renounceable "renounceable rights", rights", and after they have been traded, the rights are known as "nil-paid rights".
Partner Links To determine how much you may gain by selling the rights, you need to estimate a value on the nilpaid 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 $4.92 less $3, your nil-paid rights are worth $1.92 per share. Selling these rights will create a capital gain for you.
Test your forex trading skills in our FX trading simulator Trade like a top hedge fund manager using technical analysis and double your wealth... Learn to trade stocks by investing $100,000 virtual dollars...
The Bottom Line
It is awfully easy for investors to get tempted by the prospect of buying discounted shares with a Topics thatReference Advisors Markets Simulatorthe rights issue. But it is not always a certainty you are getting a bargain. But besides knowing 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 Search news, tickers, 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 doesn't necessarily mean management will address the underlying problems that weakened the balance sheet in the first place. Shareholders should be cautious.
Newsletters
Compete, Risk Free with $100,000 in Virtual Cash
Put your trading skills to the test with our free Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own capital.
http://www.investopedia.com/articles/stocks/05/062905.asp
2/4
2/2/2017
Understanding Rights Issues | Investopedia
RELATED ARTICLES INVESTING
Stock Rights Issue Rights are offers that allow existing stockholders to buy additional shares at a predetermined price, for a set time period. Usually, the number of shares the investor can purchase are in proportion ...
INVESTING
How Does Dilution Work? Dilution refers to the reduction in the percentage equity ownership of a company due to additional equity being issued to other owners.
MANAGING WEALTH
Knowing Your Rights As A Shareholder We delve into common stock owners' privileges and how to be vigilant in monitoring a company.
INVESTING
What Are Corporate Actions? Be a savvy investor - learn how corporate actions affect you as a shareholder.
INVESTING
Getting The Real Earnings EPS helps investors analyze earnings in relation to changes in new-share capital.
Topics INVESTING
Reference
Advisors
Assess Shareholder Wealth With EPS
Markets
Simulator
Find out if management is doing its job of creating profit for investors.
Search news, tickers,
Newsletters
INVESTING
The Dangers Of Share Dilution Investors need to be aware of the existence of dilutive securities and how they can affect existing shareholders.
INVESTING
The Basics Of Outstanding Shares And The Float We go over different types of shares and what investors need to know about them.
http://www.investopedia.com/articles/stocks/05/062905.asp
3/4
2/2/2017
Understanding Rights Issues | Investopedia
INVESTING
How To Sell Put Options To Benefit In Any Market Selling a put option is a prudent way to generate additional portfolio income and gain exposure to desired stocks while limiting your capital investment.
RELATED FAQS Q: Why would a company issue a rights offering? Understand more about a rights offering, and learn the most common reasons a company might have to issue a rights offering, ... Read Answer >>
Q: What is a direct rights offering? Discover what a direct rights offering is, what it means for shareholders who receive the offering, and the reasons a company ... Read Answer >>
Q: Why is the value of capital stock important to public shareholders? Understand what capital stock is and how it's issued and authorized. Learn why the value of capital stock important to public ... Read Answer >>
Q: What are some characteristics of ordinary shares? Read about some of the primary characteristics of ordinary shares, also known as common shares, including voting rights and ... Read Answer >>
Q: Why is an increase in capital stock on a company's balance sheet a bad sign for stockholders? Understand what capital stock represents for a company and understand the significance for investors when a company initiates ... Read Answer >>
Search Investopedia
Topics
DICTIONARY:
#
A
B
C
D
Reference
E
F
G
Advisors
H
I
Markets
J
K
L
Simulator
M
N
O
P
Q
R
Search news, tickers,
CONTENT LIBRARY Articles
Stock Simulator
T
U
V
W
X
Y
Newsletters CONNECT WITH INVESTOPEDIA
Videos FXtrader
Guides
Slideshows
Exam Prep Quizzer
FAQs
Calculators
Chart Advisor
Net Worth Calculator
WORK WITH INVESTOPEDIA
S
With Us
© 2017, Investopedia, LLC.
Stock Analysis
HcrIJ
GET FREE NEWSLETTERS Write For Us
Us
All Rights Reserved
Careers
Of Use
http://www.investopedia.com/articles/stocks/05/062905.asp
Newsletters
4/4
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