We know that in many stock forums you have encountered a word “Rights Issue”. And you may have tried to know that what a “Rights Issue” is? Why, How, and to Whom the Company Offers the “Rights Issue”? And What are the benefits and Cons of Rights Issue? Now your search ends here as we would be discussing all of that in detail.
What is Rights Issue of Shares?
A rights issue of stock is a way by which a listed company can raise additional fund from the public. It is like an FPO but has a catch; it is only available to the company’s existing shareholders. A rights issue or rights offering provides a right but not the obligation to the company's existing shareholders to buy additional shares directly from the company proportionate their existing holdings, within a fixed period of time.
[Read More: FPO vs Rights Issue: What's the Difference?]
In a rights issue, the subscription or buying price at which the company offers each share is usually offered at a discounted rate than the prevailing market price of that stock. These rights are usually transferable, allowing the holder to sell them on the open market instantaneously.
For example, 1:3 rights issue signifies that an existing investor can buy one extra share for every four shares he/she held in the demat account.
Benefits or Pros of Rights Issue:
Companies usually offer rights when they want to raise additional money. The benefit to a company in raising money through rights issue is that the company can bypass underwriting fees.
Although many companies release rights issue for gain stockholders confidence. In many cases, the company may use this rights issue method to raise money if there are no other viable financing alternatives. This is very common during economic slowdowns when banks are unable to lend more money to companies.
The pros of a rights issue to shareholders are that shares are usually offered at a discounted price. Occasionally this discount can be quite steep; it all depends on how much the company feels it needs to encourage its shareholders to buy the rights issue.
Disadvantage or Cons of Rights Issue:
A rights issue by a well-established company may be assumed by the market as an indication that a company is struggling. This is because rights issue flood the market with more shares, lowering the company's earnings-per-share (EPS). Shareholders can become dissatisfied when their shares are diluted. But, a rights issue is meant to minimize this concern because only existing shareholders are given the chance to buy additional shares.
What You Can Do With Rights Issue:
As a shareholder, basically you have three options to act in response to the rights issue. You can (i) subscribe to the rights issue in full, (ii) ignore your rights or (iii) sell the rights to someone else. Let's take a view on how to act on each option and the possible outcomes.
(i) Subscribe to the rights issue to purchase in full:
To take advantage of the rights issue in full, you would need to pay the full amount according to the number of shares you are allowed to purchase. As you are getting the shares at a discounted price the average share price would be lower than the total current market value. So if you buy those shares and sell them immediately then also you would be in a profit. But you need to take into consideration that a lot of times after rights issue the market price of the stock price of that company fall. You need to anticipate the fall in market price before taking on the buying decision.
(ii) Ignore the Rights Issue:
If you do not have the total amount of money required to purchase the rights, or simply you don't intend to purchase more stocks, then you can simply ignore the rights offer and wait for the offer to expire. But this is not typically recommended. Because If you choose to ignore the rights, your shareholding will be diluted because of the extra shares issued by the company.
(iii) Sell your rights to other investors:
In most cases, your rights allow you to choose whether you want to buy those shares or sell your rights to other investors or to the underwriter. Rights that can be traded or sold are called "renounceable rights," and after they have been traded, the rights are called "nil-paid rights.". But in some cases, rights are not tradable or transferable. This type of rights is known as "non-renounceable rights. Check the type of rights before taking any decision.
Should You Buy Rights Issue? – The Conclusion:
Being an investor, you should be able to look beyond the discount offered. A rights Issue is much different from bonus issue, as here you have to pay money to get additional shares. Hence it is advised that you should subscribe to it only if you are very much sure about the company's future performance.
See our guide on What's the difference between rights issue and bonus issue?
Also, you should not subscribe to the rights if the share price has fallen below the subscription price. In that case, you can purchase the share at a cheaper price in the open market.
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