Wednesday, 27 February 2008

Rights issues are a safe bet in bear market situations

Rights issues are a safe bet in bear market situations

Prerna Katiyar, TNN

MUMBAI: Companies like SBI, Exide Industries and Gujarat NRE Coke recently announced rights issues. While their share prices have reduced considerably in the recent meltdown, they’re still trading above the rights price.

The equity market has seen a sharp correction in the past week. Just a couple of weeks ago, companies like SBI, Gujarat NRE Coke announced issuance of rights shares. SBI, for instance, announced a 1:5 rights issue at a price of Rs 1,590 per share.

While the share prices have seen correction (it was at the Rs 2,400-level some days back) to Rs 2,159, the rights price is still at a 25% discount to the latest market price. After adjusting for equity dilution, it’s still available at an 11% discount. The discount factor has reduced, but long-term investors could still consider rights issues like that of SBI, Exide Industries, Gujarat NRE Coke, Dhanalakshmi Bank, Centurion Extrusion if they are upbeat about business prospects.

What is a rights issue?

Rights issues are shares issued by a company only to its existing shareholders. In fact, rights issue is a method of raising further capital from the existing shareholders/debenture holders by offering additional shares on a pre-emptive basis, usually at a discounted price. The number of shares offered depends on the number of shares already held and other terms made in the offer. For example, if you hold 200 shares in XYZ and it makes an offer of one-for-two, you can buy up to 100 shares at the price stated.

Why the discount?

The main idea behind this is to make the issue attractive for its shareholders. Also, as the shares of the company usually fall post-issue due to equity dilution, it makes sense for the company to offer the shares at a discount.

Why does the company offer a discount and not go in for a further public offering (FPO)?

It’s money and nothing else. The company makes the offer to raise capital. This is done either to expand its existing business, set up a new plant, or even pay back loans. “It is largely because the company want to pass on the benefit to its existing shareholders that it makes the rights issue rather than going in for an FPO,” says SBI MF manager Jayesh Shroff. Also, the transaction cost for a rights issue works out to be lower than going in for an FPO.

I’m not a shareholder, can I still benefit from rights issue?

Yes, provided you become a shareholder of the company before the record date. While declaring a rights issue, a company also declares the record date or the date on which a shareholder must officially own shares in order to be entitled for the issue. For SBI, it is February 4, 2008.

One thing to be kept in mind is that you will not be entitled for rights issue if you buy the share on this date. You need to buy the stock two days before the record date for becoming a shareholder. Another important date to keep in mind is the closing date.

What options do you have?

Rights issue is offered to all its existing shareholders individually and you have the choice to reject it (which means, not to subscribe for any shares), accept it in full (subscribe for all the shares offered) or accept it in part. So you do have a right to say no to it.

Can I go in for more shares than offered?

Usually, shareholders are given a chance to subscribe for more shares than offered. Although, there is no guarantee that those number of shares will be allotted.

Is rights issue transferable?

Yes. You can sell them in the open market or transfer it.

Should one always go for it?

“Provided the investor is confident of the company’s management and the business model, one can go for the issue for the simple reason that he is getting the stock at a discount than the present market price,” adds Mr Shroff. Although, in a falling market, the lucrativeness of the offer is falling day by day, one may consider these issues as one is aware of the trading history and performance of the stock.

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