Quick guide to rights issues and other corporate actions
Rights issues, share splits, demergers, consolidations and share buybacks: there is a long list of things quoted companies can do which can affect your shareholding. We offer a guide to some of the more common.
A rights issue is a way for a company to raise new capital by issuing new shares. Company law states that, in most cases, existing shareholders should have first refusal for these shares, known as pre-emption rights, so the new shares will be offered to investors in proportion to their existing holding.
The usual reasons for a company to launch a rights issue are either to fund expansion, whether by acquisition or capital investment, or to repair the balance sheet. The issue will be accompanied by a prospectus, similar to that for a stockmarket flotation, outlining the reasons for the issue and the risks attached.
The new shares will invariably be offered at a discount to the current market price to encourage shareholders to take them up and to protect the issue against any falls in the stockmarket generally, and in the company's shares in particular, before the issue closes: the riskier the issue is perceived to be, the bigger the discount required.
A refinancing rights issue, for example, will usually have to be heavily discounted: travel company FirstGroup (FGP), for example, priced its £615 million rights issue to repair its balance sheet at 85p, more than 60% below the price at which the shares were trading before the issue was launched. A rights issue for expansion may be more warmly received by investors, depending on the company's proposal, so the new shares could be offered at a lower discount.
Rights issues are usually underwritten, which means that an investment bank guarantees to buy any shares which are not taken up by the company's shareholders and places these with institutional shareholders. There is a fee for underwriting and there have been attempts to reduce the costs of rights issues by offering such a deep discount to the existing shares, hence the term deeply discounted rights issues, that shareholders would be bound to take it up.
Today, however, companies generally offer both a sizeable discount and have the issues underwritten. That reflects the reluctance of investors to commit new money to the stockmarket in the current uncertain economic climate.
The price of the company's shares will generally fall after the rights shares have been issued to reflect the fact that new shares have been issued at a discount. Analysts will calculate a theoretical ex-rights price to help them assess whether it is worth subscribing to the new issue. This is worked out by adding the value of the existing shares to the amount required to subscribe for the new ones, then dividing that by the increased number of shares in issue.
For example, if you hold 100 shares priced at £10, and are offered one new share for every 10 held, priced at 700p, the theoretical ex-rights price will be calculated as £1,000 (100 x £10) plus £70 (10 X £7) divided by 110 (100 existing shares plus 10 new ones), or £9.73. If the theoretical ex-rights price drops below the rights price, there would be no point subscribing for new shares.
Your rights issue options:
If a company you are investing in has a rights issue, you have four main options:
- Subscribe for the new shares, which means you have to invest more money in the company.
- Do nothing and let your rights lapse, although you should be aware that by doing so you will be diluting your stake in the company, including your entitlement to future dividend payments. If you do this, your rights will be offered for sale to other investors and you will be sent any proceeds by the company's share registrar.
- Sell your rights to take up the shares in the market. The company's registrar may offer this service as part of the rights issue process.
- A combination of 1 and 3 under which you sell enough of your rights to finance the take-up of the remainder.
Your decision on which option to take will depend both on your financial situation and the reception of the rights issue. If the company's existing shares fall below the price the new ones are being offered at - as happened with the rescue rights issues launched by banks such as Royal Bank of Scotland (RBS) at the height of the financial crisis - there is no point in subscribing as you can buy the shares more cheaply on the stockmarket. An issue to finance expansion by the company is likely to be better received than a rescue, or refinancing, issue.
If the rights issue is large, the company's share price may be depressed for some time afterwards as the market adjusts to the new supply.
A demerger means splitting a company in two. This is usually undertaken because the parts of the business do not have much in common - they may be separately run, in different sectors or geographical locations - and the management believes that keeping together means that one, or both, parts are not being correctly valued by the stockmarket.
A demerger can be accompanied by a rights issue to raise money for one or both parts of the business.
A share consolidation is used to reduce the number of shares a company has in issue. It is commonly used where the share price has fallen substantially - RBS, for example, consolidated its shares in the wake of the financial crisis as a way of making the shares less volatile. Existing shareholders will end up with a smaller number of shares but their stake in the company and their share of the dividends will be exactly the same as before.
The opposite of a consolidation, a share split can be used when the price of a share has increased so much that buying just one share is very expensive. Companies which have used this include Alliance Trust (ATST). While a split means investors will end up holding more shares, again their effective stake in the company will remain the same.
Scrip or bonus issue
The issue of new shares to all shareholders, made as a sign that the company is in good health and has excess capital which it can return to shareholders. They can be more tax efficient for investors than a special dividend, where investors have to pay income tax on the proceeds, as scrip shares can be sold for a capital gain.
A one-off dividend paid to all shareholders, usually made when a company has a large amount of cash and retained earnings which it does not need for investment.
A company buys back and cancels some of its shares. The result is that the number of shares in issue falls so the earnings and dividends will be divided between a smaller number of investors. Buybacks are generally only used if the company's share rating is low enough to mean that a buyback will be beneficial to its earnings per share. Through their broker, companies will normally buy back shares held by large institutions; private shareholders rarely get the chance to participate.
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