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Reliance Industries did India’s largest-ever rights issue of ₹ 53,125 crore. In Oct 2021, Bharti Airtel announced a rights issue of ₹ 21,000 crore.
What are Rights Issues? Why do companies do Rights Issues? Why are they only available to existing shareholders? What should shareholders consider before exercising their Rights Entitlement? How to apply for Rights Issue?
This post breaks it all down, minus the jargon.
There are two types of capital that a company can use to fund operations – debt and equity. In the case of debt financing, the company needs to repay the amount borrowed with interest, while in the case of equity, the company is not required to repay shareholders. There are some quasi-equity instruments also available, which is a mix of debt and equity.
What is a Rights Issue?
In a rights issue, a company raises funds by issuing more shares, but only to existing shareholders.
That is, if you own a share, you get the “right” to buy more shares – in a certain ratio, at a certain price. For example, a 10:1 issue means you get the right to buy ONE share for every TEN shares you own. Rights are offered to only those shareholders whose names exist on the register of shareholders of the company on a record date, which usually happens a few days after shareholders approve the proposal to raise money through rights.
Why Rights Issue?
If a company raises money through a Follow-on public offer, it has to go through a long process that involves getting merchant bankers to price the issue, offer document approval by SEBI, etc. Plus, there’s a whole bunch of fees that need to be paid.
The rights issue is the fastest and the most economical method of raising capital for the company. The company saves a significant amount of money on expenses such as underwriting fees, advertisement costs, and so on that it would have incurred in any other kind of fundraising.
Why is the regulator less stringent on rights? The rationale is that a current shareholder already knows a reasonable amount about the company; she doesn’t need the same level of scrutiny and disclosures compared to selling shares to new shareholders.
Also, in a rights issue, the promoter holding does not get diluted, unlike any other fundraising method via equity. Usually, promoters commit to fully subscribing to their portion of the rights and the undersubscribed portion.
Rights Pricing & Ratio
Generally, rights offers are priced at a discount to the market, and allotment is assured. If the rights are issued around the current market price, existing shareholders may not be too interested.
Depending on the funds it wants to raise, and at what price, a company decides the ratio in which to offer rights shares. For instance, recently, Bharti Airtel decided to raise ₹ 21,000 crore at ₹ 535 by offering its existing shareholders one additional share for every 14 held on the record date. This means that a shareholder with 1,400 shares will have the right to get an additional 100 shares of the company at ₹ 535 each (market price was much higher at that point, nearly around ₹ 680).
The ratio guarantees the number of shares that one will be allotted. However, one can apply for more shares as well.
Also, these Rights by themselves are tradeable for a limited period of time, allowing existing shareholders to sell them on the exchange to other investors. For example, for a limited time, the recent Bharti Airtel Rights trade on the exchanges as ‘AIRTEL-RE-BE’. As of writing this, the Airtel Rights are trading at ₹ 203, which means a rights holder would buy an Airtel share at ₹ 203 + ₹ 535 = ₹ 738. Airtel shares currently trade at ₹ 687.
Since Airtel is part of the CM Focused Portfolio, we wrote about the action existing holders need to take: What to do with the Airtel Rights Issue? [Premium]
Future Return on Equity and EPS (Earnings per Share) will dilute when a company issues additional shares. However, if the rights offer is fully exercised, then the shareholding of any investor does not get diluted. For instance, if a shareholder holds a 5% stake in a company pre-rights, the holding even post-rights will continue to be at 5% if he subscribes to his rights shares. Suppose the shareholder chooses not to exercise the rights offer, then his shareholding in the company would fall (since others will buy and their shareholding goes up).
Applying for more shares than your rights gives you the ability to buy more if a few investors decide not to subscribe, either because they have ignored or missed the intimations or because they don’t want to.
Rights are an option that a shareholder may or may not exercise. If a shareholder exercises the rights offer, they will have to pay the rights price into the number of shares eligible. If a shareholder is not interested in adding more shares of the same company, they can either transfer or forfeit their rights.
It’s simple: I have the right to buy more shares, but I renounce the rights in your name, so now you (who may not even be a shareholder) get to buy the shares at the rights issue price. For doing this “renunciation”, I might charge you a fee. For a company trading at ₹ 700, if the rights issue is at ₹ 500, I will charge ₹ 200 per rights entitlement to renounce them in someone else’s favour.
Let us understand this with examples of recent rights issues – Bharti Airtel & Kesoram Industries. Once a shareholder holds the shares on the record date, their Demat account gets credited with “Rights Entitlement”.
What is “Rights Entitlement”?
This is relatively new in the Indian stock market, where the entitlement itself is traded on the exchange.
Rights Entitlement (RE) is issued to shareholders by a company launching rights issue. RE’s are issued as part of the rights issue, in the same ratio, to the shareholders as on the record date. Continuing with the earlier example, a shareholder with 1,400 shares of Bharti Airtel will get RE for 100 shares.
Last year, Reliance Industries was the first company to credit the rights entitlement of its shareholders directly to their Demat accounts so they could trade them on the exchange platform.
When you sell an RE, you renounce your rights in someone else’s favour. The buyer of the RE gets the right to buy the shares.
Getting RE shares does not mean you have got the rights shares. An investor needs to apply for rights shares based on entitlements received separately. RE is a temporary credit of shares in the Demat account, which allows the rights holders – who are not interested in adding more shares of the same company – to sell their RE shares on a trading window on exchanges to other willing investors for a price.
Until now, shareholders, who didn’t wish to apply, had to let their RE forfeit. The renunciation process was complex and required paper signatures of the buyer and seller. But with the process run on the exchange, things are far easier – just a click on your broker’s platform, and it’s sold. Issuing RE shares allows shareholders to gain some value from their RE shares.
Determining RE price
The rights entitlements price is calculated as the difference between the stock’s market price back then and the price at which the rights issue is offered. Once the base price is fixed, the further movement in pricing depends on the market sentiments and demand and supply of the RE. For instance, Airtel’s rights share are on offer at ₹ 535, and the market price of Airtel during that time was around ₹ 681 per share. Thus, the base price or the intrinsic value of RE was ₹ 146. However, it hit an upper circuit of 40% on the first day and closed around ₹ 205.
Why would someone pay MORE for the Airtel share than ₹ 146? The answer lies in the actual issue, which is for partly paid shares, not regular shares. These shares don’t need the full amount paid upfront – they will be paid in parts over time. That adds a layer of “optionality”, which is why the RE trades at a higher value (₹ 205) than the “intrinsic” difference of ₹ 146.
Whenever a company raises capital from shareholders, it issues them shares, representing their stake in the company. These shares can be either fully or partly paid. In the case of fully paid shares, the company collects the entire amount at one go, while in the case of partly paid shares, it collects money in installments. A company following the latter route does not need the entire amount raised at one go. Further, it also gives time to shareholders to pay for their shares.
With partly paid shares, investors get an opportunity to buy a company’s stock at a lower price. But they need to pay the remaining installments when due. Once all the installments are paid on these shares, they are converted into fully paid shares and traded at the same price. (Voting rights and dividends for these shares are correspondingly lower)
For instance, RIL’s rights issue was priced at ₹ 1257 apiece. However, the company was supposed to collect the money from shareholders in three installments –
- ₹ 314.25 at the time of allotment,
- ₹ 314.25 by May 31, 2021, and
- The final payment of ₹ 628.5 is due in November 2021.
Tata steel was the first company to list its partly paid shares on the bourses.
Pricing of “Partly Paid” shares
Like fully paid shares, these partly paid shares are also listed on the stock exchanges for buying and selling. Their price is dependent on the company’s fully paid stock price, the amount of the installment paid, the approximate time left to pay the rest, the volatility of the stock, and of course, demand-supply. The part of the amount paid in the case of partly paid shares is considered the issuance price or the base price.
For instance, RIL partly paid shares were listed on June 15, 2020. On listing day, the partly paid shares listed at ₹ 698 – more than double the base price of ₹ 314.25. The difference reflects the fact that:
- There was about ₹ 943 remaining to be paid.
- Reliance (fully paid share) was at ₹ 1615.
- The difference (₹ 1,615 – ₹ 943) is ₹ 672, which should have been the price of the PP (partly paid) share.
- But it traded at ₹ 698. The slightly higher price accounts for the volatility and time-value of the money for about 1.5 years, the expected time in which Reliance was expected to call the rest of the money.
Since then, Reliance has made the second call of ₹ 314.25, taking the total paid amount to ₹ 628.5. In October 2021, the PP trades at ₹ 1,944, which looks like a 200%+ return, but it’s largely because the inherent leverage in the partly paid share makes it behave like an option (where the upside is higher, and so would the downside if Reliance were to have fallen)
How To Apply For Rights Issue
An investor interested in applying for rights shares can do so online via net banking or UPI. To apply for the shares, a shareholder can visit the website of the Registrar & Transfer Agents, or they can log into the net banking website of their bank and head to the ASBA section. They can then proceed to buy the rights in the same way as an IPO.
To explain the procedure, we are considering the ongoing rights issue of Bharti Airtel.
Step One:- Visit the Registrar’s website; in this case https://rights.kfintech.com/airtel/
Step Two:- Click on “R-WAP”; check all the boxes and click on proceed
Step Three:- If you were a shareholder as on record date and have received RE, then check the first box, and if you have purchased RE on the exchanges and continue to hold the same, then check the second box
Step Four:- Enter your DP ID and Pan No. and click on submit
Step Five:- Confirm your email address and mobile number and validate the OTP received
Step Six:- Here, an investor needs to manually fill the number of shares they want to apply for. Even if an investor has 100 rights shares entitled, they can apply for more or less
Step Seven:- On choosing either of the options – net banking or UPI, the registrar’s website will redirect you to the bank website, where an investor needs to fill in its bank details and confirm
After a successful transaction, the investor will receive an email confirmation of the same. If the investor has applied for more shares, and the number of shares allotted was lower, the difference amount gets refunded.
Step One:- Login to your net banking account; in this case, HDFC net banking account.
Step Two:- Click on ‘IPO/Right Issue’ under ‘Request’ on the left side menu.
Step Three:- Click on apply of Bharti Airtel’s rights issue
Step Four:- Fill in the details; like above, an investor can apply for more shares; click on proceed and confirm
With dematerialization of RE and online application of rights issues, applying to a rights issue is much easier. With the listing of RE and partly paid shares, it is easy for an investor to enter and exit the rights issue process at any point of time at a market-derived price.
Recently, the strong gains in the Reliance rights issue have lured many investors looking for quick returns. The rights entitlement of companies that came with rights issues has traded at abnormal prices compared to their actual market price. Many investors have taken the plunge and bought these instruments without knowing what it is.
For instance, Reliance Partly Paid shares have gained more than 200% since it was listed on June 15, 2020. In that same time period, RIL shares have gained only close to 60%. On the flip side, Gateway Distriparks’ RE opened on July 30, 2020, at ₹ 11.06. The RE price went as high as ₹ 42.4 on August 5, 2020, and finally closed at ₹ 14 on August 7, 2020.
Partially Paid shares through rights issues are leveraged instruments, and thus the returns are amplified on the upside and are much worse when the stock falls. We have used the leverage treating the partially paid share as equivalent to a stock option (links below), but please note that this is not a risk-free strategy.
The prospect of buying shares at a “discounted” price is tempting. This does not work all the time. For instance, in 2019, when Vodafone Idea’s share prices were around ₹ 34, the company had launched a rights issue at ₹ 12.5. Currently, the share prices of Vodafone Idea are trading even below the rights issue price.
The return potential from buying or exercising a Rights Issue is tethered to the prospects of the underlying business to generate returns above the cost of capital.
An investor needs to understand the purpose of additional funding and factor in the future growth prospects. Sometimes, despite strong growth prospects, there could be a compelling reason to exit.
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