Rights issues are an invitation to a company’s existing shareholders to buy additional new shares in the company. This is done in a fixed proportion to their existing shares. The shares issued in a rights issue are priced below the current market price to make them attractive to shareholders.

For example, if XYZ Company held a rights issue with a one for two ratio, you would receive 500 additional shares for every 1,000 shares you own if you decided to participate. If you failed to buy your additional rights, you would be risking having your stake diluted.

Understanding Rights Issue: The quick takeaways

i). They’re a common method of raising additional capital.

ii). They’re shares usually offered at a lower price than the stock’s current market price.

iii). Their maximum entitlement is shown by a ratio. For example, 5 new shares for every 15 shares held.

Provisional Allotment Letters (PALs) for the rights issue are created and sent to all shareholders in the company holding the rights issue.

The shareholder has the right to:

i). Pay for all or some of the shares.

ii). Sell the rights to all or some of the shares. This is referred to as Nil-Paid selling.

iii). Pay for shares and re-register them in someone else’s name.

iv). Allow the rights to lapse.

When selling the rights to all or some of the shares, or allowing the rights to lapse, the shareholder could receive a payment for any premium gained.

Ex-Rights

These are shares that are trading at the Nairobi Securities Exchange (NSE) but which no longer have rights attached to them. This is usually because they have been transferred to another investor, they have expired, or they have been exercised. Normally, shares of stocks that are ex-rights entitle the seller to retain the right to participate in any other fresh rights issue.

What to do before buying rights

A worthy rights issue will mainly be dominated by the majority shareholder and, or institutional shareholders who clearly state their long term outlook for the company holding the rights issue, and who are willing and able to defend their stake. For example, KCB Group placed a rights issue, the National Treasury, which is the majority shareholder, would have to declare if it will take up its rights.

In the same vein, a rights worth participating in will have mainly institutional shareholders who have stated their long term outlook for the company, are willing and able to defend their stake. The rights price should be a discount of more than 20% of the average weighted market price over the past 6 months. The ratio should not be too dilutive, a smaller ratio is better. If the above is not met, the shares would be cheaper to buy post rights, all macroeconomic factors held constant.

Questions to address before buying

On the company’s shareholders:

i). Who are the main shareholders? Are they institutional, governmental bodies, foreigners or local investors?

ii). Do the shareholders have enough capital to defend their shares?

iii). Do the main shareholders intend to sell their extra shares after the rights issue?

On the buying price:

i). Is it at a discount or a price higher than the original market price – also known as premium?

ii). If it is discounted, how cheaper are the new shares compared to the prevailing market price?

On ratio of rights:

i). What is the total number of issued shares?

ii). How many shares have been issued so far?

iii). How many shares will be issued in the rights?

On purpose of rights issue:

i). How does the company plan to utilize the money raised from the rights issue?

ii). Does this plan have any potential of increasing future cash flows for the company?

iii). What is the company’s debt level? Does it have minimal debts or is it struggling with debts?

READ MORE: Standard Media to ask for Sh1.5bn from shareholders in rights issue