What is rights issue? How does it work and its effect on stock price?
A rights issue is an invitation to current shareholders to buy more new shares in the company. Company is issuing additional shares to raise capital. This type of issue provides existing shareholders with securities known as rights. Shareholders can choose to execute the rights or not. If they choose to execute, they can use the rights to purchase new shares at a discount to the market price on a specified future date. The company is allowing shareholders to increase their exposure to the stock at a reduced price.
How it affects stock price?
To raise additional capital, companies most commonly issue a rights offering. A business may require additional capital to meet its current financial obligations. When a company is in financial trouble, it will typically use one type of corporate action which is rights issues to pay down debt, especially if they are unable to borrow more money. Because more shares are issued to the market, as a result of a rights issue, the stock price is diluted and is likely to fall.
However, not every company that pursues rights offerings is in financial distress. These issues could be used to raise additional capital to fund expenditures aimed at expanding the company's business, such as acquisitions or the opening of new manufacturing or sales facilities. If the company uses the extra capital to fund expansion, despite the dilution of the outstanding shares as a result of the rights offering, it may eventually result in increased capital gains for shareholders.
How rights issues work?
For example, let's say you own 100 Apple shares, each of which is worth USD150. It announces a rights offering through which it plans to raise $30 million by issuing 10 million shares to existing investors at a price of $100 each. The ratio is a three-for-10 rights issue, which means that for every 10 shares you hold, Apple is offering you another three at a deeply discounted price of $100. This price is 33% less than the $150 current market price.
With a rights issue, as a shareholder, you have three options.
1. Fully support the rights issue
You'd have to spend $100 for each Apple share you're eligible to buy under the terms of the issue. You can buy up to 30 new shares (three shares for every ten you already own) at the discounted price of $100 for a total price of $3,000 if you own 100 shares. Despite the 33 percent discount on newly issued shares, the market price of Apple shares will not be $150 after the rights issue is completed. As a result of the increased number of shares issued, the value of each share will be diluted.
2. Ignore your rights
If you don't have the $3,000 to buy the additional 30 shares at $100 each, you can always let your rights expiry. However, this is not normally advised. If you do nothing, your shareholding will be diluted due to the additional shares issued by the company.
3. Sell your rights to someone else
Rights are not always transferable. However, in most cases, your rights allow you to choose whether to exercise the option to purchase the shares or sell your rights to other investors, the easiest way is by trading it in regular market.