Rights issue: How to decide to apply in the rights issue?

Anthony Fernandes
/ Categories: Knowledge
Rights issue: How to decide to apply in the rights issue?

A company may raise funds in a number of ways apart from IPOs and bank loans. Many Indian companies such as L&T Finance Holdings Limited, PVR Cinemas and Reliance Industries have raised funds through a rights issue in the middle of the COVID-19 pandemic. For many companies, it is a fast and effective way to raise money, unlike the lengthy process of an IPO. Today, we will understand this concept in detail and also, look at the factors that you must take into consideration before taking part in a rights issue.   

Before we delve into the topic, we need to understand what the rights issue is! It is simply a primary market offer to the existing shareholders to buy additional shares of the company on a pro-rata basis within a specified date. However, the shareholders are not going to be interested in the rights issue if it is at the current market price; so, a rights issue is often available at a discounted rate to the existing market price. If the company announces a rights issue in a ratio of 2:5, the shareholders can buy two additional shares of every five shares they own at a discounted rate put forth by the company.   

It is important to note that the rights issue offer is an invitation that provides an opportunity for existing shareholders to increase their shareholding. It is a right that a shareholder may or may not choose to exercise and not an obligation to buy the shares.  

Essentially, the shareholder gets three choices with a rights issue:  

1) The shareholders can oblige and buy the company’s shares which the company expects the shareholders to do as the shares are being offered at a discounted rate to the market price.  

2) The shareholders can ignore the rights issue altogether since they are not obligated to buy these rights.   

3) The shareholders can choose to sell their issue rights to others if the rights happen to be renounceable. SEBI recently announced the rights entitlement platform, where eligible shareholders can sell their rights entitlement to others on the stock exchange like shares.   

So, what are the factors that a shareholder should take into consideration while deciding to take part in the rights issue? 

Firstly, you should not get tempted by these shares simply because they are being offered to you at a discounted rate to the market value. It may not always be a bargain. Instead, you must check the future growth prospects and possibilities of an increase in the share price from its current level.  

You also have to try and find out the real reason why the company had to announce the rights issue as it can very well reflect the financial health and the future growth outlook of the company. If the company says that they are running low on cash and needs some funds as they cannot take more debt, you need to carefully evaluate the impact of this move on the future trajectory of the company’s profitability. 

On the other hand, if the company plans to use the funds in-lieu of new facilities or to acquire competitors, you need to evaluate how well this integration will add value to the company. Many broking houses also come up with their view on the rights issue and you may want to look at their view before deciding to participate in the rights issue.  

To conclude, a rights issue may be beneficial both for the company issuing and its shareholders, who choose to partake in it as long as the company uses these funds to drive future growth.   

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