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We often hear about companies raising funds through IPOs and venture capital, but what happens when a company needs more capital for expansion after going public?
That’s where options like borrowing and rights issues of shares come into play. Recently, the headlines have been buzzing with news of rights issues from companies like IOC and BPCL.
So, let’s take a look at what is a rights issue and why does it matter.
What is a Rights Issue of shares?
A Rights Issue is an offer for existing shareholders to increase their stake in a company by purchasing additional shares at a discounted price. This exclusive opportunity allows shareholders to exercise their right to buy more shares, contributing to the company’s capital-raising efforts.
It’s important to note that participating in a rights issue is a choice, not an obligation. Shareholders have the right to decide whether they want to increase their shareholding or not. Rights issues can be both enticing and concerning for investors.
Rights Issue eligibility:
To participate in a rights issue, shareholders must meet specific eligibility criteria:
- Shares must be owned before the record date.
- Shares purchased on or after the ex-date are not eligible.
Let’s get a clear picture with an example:
Imagine a company announcing July 6, 2023, as the record date for its rights issue.
To be considered an existing shareholder, you must own the company’s shares in your Demat account on or before July 6.
If you buy the shares on July 5, even though it’s before the record date, you won’t be eligible as the credit of shares in your Demat account will occur on July 8. Remember, shares become ex-rights from July 6.
Why do companies consider a Rights Issue of shares?
- Reduce debt-equity ratio:
One common reason a company prefers a rights issue is to bring down its debt-equity ratio. To become more agile and attractive to investors.
- Capital for companies:
When companies find themselves in dire need of capital but want to avoid increasing their debt burden, a rights issue comes to the rescue. Financial lifeline without the added loans.
- Fuel for expansion and corporate objectives:
Companies may also use rights issues to fuel their growth ambitions, such as expanding their operations, making acquisitions, or pursuing other corporate objectives. Let’s come back to IOC and BPCL.
IOCL and BPCL are looking to raise capital through rights issues of equity shares to fund their respective capital expenditure plans.
BPCL aims to raise up to ₹18,000 crore to achieve energy transition, net zero, and energy security objectives. The Indian government is expected to invest ₹9,000 crore in BPCL during the rights issue process.
Both companies’ rights issues are part of the government’s plan to infuse capital in oil marketing companies to support energy transition and net-zero objectives (balance between the amount of greenhouse gases emitted and the amount removed from the atmosphere).
Procedure for the Rights Issue of shares
So, how to apply for the rights issue? Each shareholder who is eligible to receive the rights issue will get a form from the corporation. You have the option to finish the transaction online or offline.
- Investors may access ASBA services by logging into their online brokerage account.
- To see all of the available rights issues, choose the IPO/FPO/BUYBACK option.
- Please indicate the desired purchase quantity before applying.
- Select “I agree to the terms and conditions”
- Before completing the transaction, ensure that you have the necessary funds.
- Verify the order book and complete the transaction.
The impact of Rights Issue on share prices
When a company offers a rights issue, the number of shares in the market increases, leading to a share price dilution. Here is a formula to estimate the post-rights issue share price.
The Theoretical Ex-Rights Price (TERP)
TERP = (Rights Share * Offer Price + Existing Shares * Market Price) / Total Number of Shares
Let’s break it down with an example. ABC Company announces a rights issue in the ratio of 1:5, which means one share for every five held. The discounted offer price is Rs. 250, and the current market price is Rs. 300. Applying the TERP formula, we estimate a rough share price post the rights issue:
TERP = (1 * 250 + 5 * 300) / 6 = Rs. 291.67
So, we can expect the security to trade around Rs. 291.67 ex-rights. Remember, this is just an estimation, and market sentiments may sway the actual share price.
Conlcusion
Before diving into a rights issue, conduct thorough research to understand the company’s reasons for choosing this funding method. Remember:
A Rights Issue introduces additional shares and dilutes the stock’s value. If the capital raised is used for business expansion, it can lead to company growth and potential returns for investors.
FAQs
When a company resorts to a rights issue, it could indicate financial difficulties.
More shares in circulation mean profits get spread across a larger pool, impacting earnings per share (EPS).
When rights issue shares hit the open market, their value may dilute due to increased supply.
Some shareholders might perceive a rights issue as a sign of struggle and decide to sell, putting downward pressure on the share price.
In the case of slow-growing companies, a rights issue may find fewer takers.
A rights issue can be both good and bad. It allows existing shareholders to purchase additional shares at a discount, which can be advantageous if the company is poised for growth. However, it may also indicate that the company needs funds, which could be a sign of underlying financial issues. The dilution of shares can affect shareholding value, but it can also provide the company with the necessary capital for expansion or debt reduction.
Deciding to buy shares in a rights issue depends on your confidence in the company’s future performance and potential. If you believe the company has strong prospects and the discounted price is attractive, participating in the rights issue could be beneficial. However, consider the impact on your investment’s diversification and the potential dilution of shares. It’s important to evaluate the company’s reasons for the rights issue and its long-term strategy.
Indian Oil Corporation (IOC) has been a stable performer historically, with a sizeable non-oil business contributing to its revenue. It offers a decent dividend yield, which can be attractive for long-term investors. However, the stock is cyclical and can be volatile in the short term. Long-term prospects may be good if the company continues to maintain its profitability and dividend payouts. Investors should consider their risk tolerance and the company’s future growth potential before investing.
Typically, a rights issue can lead to a drop in the share price due to the dilution of equity. When a company issues additional shares, it increases the total number of shares outstanding, which can result in a decrease in earnings per share and potentially lower the stock’s value. However, the actual impact on the share price can vary based on investor perception, the company’s performance, and market conditions.