How can an investor make money from Rights Entitlement?
Rights Entitlements – a new instrument?
In January 2020, SEBI issued this circular announcing the launch of rights entitlements tradeable in Demat form. The instrument was first made available to the shareholders of Reliance Industries when its rights issue launched in May 2020.
In this post, we’ll attempt to cover everything you need to know about rights entitlements, rights issues, and rights shares of various paid-up categories.
Rights Entitlements = Coupon code for stocks
Firstly, let’s call Rights Entitlements as REs. They are pretty much like coupon codes for stocks. If you have received any of these, you have three options:
- Use your REs to buy shares at a discount price
- Sell your REs to someone else who is interested to buy the discounted shares
- Do nothing
Like a coupon code, even REs have an expiration date. You need to figure how you would like to use these REs before it gets expired.
If you choose to do nothing, then you will lose the entire value associated with the RE.
How do you get an RE?
If you are a shareholder of a particular company on the record date announced in the rights issue scheme, then you will automatically receive the RE units you’re eligible for in your Demat account. Along with the record date, the company also announces the ratio in which it will distribute the REs to its shareholders.
For example, assume the company announces that the shareholder is entitled to receive 1 RE for every 10 shares. Now, if you have 100 shares in your Demat account, then you will receive –
= 10 REs.
These 10 REs will be credited to your account on or before the right issue opens, and the REs get listed to trade.
In the example we discussed above, you receive 10 RE in your Demat account. You can use this 10 REs to apply for 10 rights shares.
If you wish to buy more than 10 right shares, say 20, then you need to buy 10 more REs from the market. If you don’t buy the additional REs and apply for 20 rights shares, you will be guaranteed to receive 10 and may or may not receive 10 additional rights shares depending on the demand.
This is one of the reasons why REs were made tradable in the market. For a better understanding, it makes sense to dig into the past and understand another important need for REs to be tradable.
REs were not traded on the exchange before 2020. Physical rights applications were sent to investors or could be downloaded from the Registrar’s portal.
Consider this –
In April 2019, Vodafone Idea had launched a rights issue in which the rights shares were issued at a significant discount to the prevalent market price at Rs 12.5. The market price was around Rs 30 per share at that point.
For every 38 shares held by a shareholder, one could apply for 87 more shares.
The data for the right issue is as follows –
Stock Price before the right = 30
Assume an investor held 1000 shares of Vodafone, his total investment would be worth –
1000 x 30 = 30,000
Now, by holding 1000 shares, the investor is eligible to apply for 2,289 right shares. Let’s say the stock price stays fixed at Rs 30. Then,
Rights adjusted stock price = (Total value of rights shares + Total value of present shares)/Total number of shares after the rights issue
= Rs 17.82
Post rights value of original holdings = 1000 x 17.82
= Rs. 17,820
Rights Entitlement value = Right adjusted stock price – Price of rights share
= 17.82 – 12.50
= Rs 5.32
Value of your 2,289 REs = 2289 x 5.32
= Rs 12,177.48
You now know the value of your 2289 REs but you don’t want to use them to apply for the Vodafone Idea rights shares. You decide to sell your REs for which you will have to find buyers for it. If you’re unable to find a buyer during the rights issue period and also don’t apply for the rights shares yourself, then you lose the entire value of your REs which is worth Rs 12,177.48.
SEBI understood that a small investor might face difficulty in selling the physical rights application form if they don’t want to apply for the rights shares themselves. Hence, the new Demat way to trade REs was introduced allowing investors to decide on whether they should apply for rights shares more freely.
Things to note before you trade
REs are listed on the stock exchange on the day the rights issue opens and can be traded on the exchange for about a week before they are delisted permanently.
While trading the REs, you should keep in mind the intrinsic value of rights shares. The market price of the RE may sometimes be very far in discount or premium to the intrinsic value (i.e. Rights Adjusted Price of Shares – Price to be Paid for Rights Shares).
You will not be able to transact them intraday as they are settled on a trade-to-trade basis. If you purchase an RE on Monday, it will be in your Demat account on Wednesday and will be able to sell it from Thursday onwards.
This means, if you buy REs on the last two days of trading you will not have an option to sell them back on the market since they will be delivered to your Demat account after the trading period has ended and you will only be able to apply for the rights shares using the REs you’ve bought.
When you’re buying REs directly from the market, you get the right to apply for the rights shares being issued. This would be helpful only if you apply for the rights shares or they will lapse worthless.
The application window opens when RE trading starts and stays open for a minimum of four days after the REs have been delisted from trading. You will lose the entire value of any unused REs that remain in your Demat account after the application window closes.
You can apply for the rights shares at any time during the issue period from the Registrar’s website by making a payment directly or by using net banking ASBA to block funds in your bank account for the rights issue.
You can check the details of the application process on the website of the company’s Registrar. The company or its Registrar will also send the details to you on the email ID registered in your Demat account.