Companies often announce Share Rights Issues as part of capital raising efforts to fund new asset purchases, develop new projects or simply shore up balance sheets.
Plenty of ASX 200 companies have conducted rights issues in the past 18 months including Atlas Arteria (ALX), Domain Holdings (DHG), Regal Partners (RPL), and GUD Holdings (GUD).
What are they? In basic terms – A rights issue is the offering of new shares by a company to existing shareholders.
The key difference between a rights issue and an initial public offering is that the latter is offered to the general public, whereas the former is not.
Types of issues – There are two general types of rights issues:
- Renounceable rights issues provide investors with the opportunity to on-sell their entitlement in the open market. This is an attractive feature because it allows investors to receive some benefit if they do not wish to purchase the new shares
- A non-renounceable rights issue cannot be traded to others, and as such are of no value to investors who do not take up their entitlement.
Why do it? The reason for a rights issue is pretty much identical to why a company would want to raise capital – M&A, fund growth, bolster balance sheets etc.
A heavily indebted company might be restricted from borrowing or raising new debt. Similarly, a company may wish to take advantage of its high share price. In these situations, a company could turn to existing shareholders to provide it with the necessary capital.
The effect of rights issues – The impacts of right issues are also identical to typical capital raisings. This includes:
- Dilution to existing shareholders: When a company issues more shares, the percentage of the company each shareholder owns is diminished. This is unless shareholders take up their entitlement offer in full
- Impact on earnings metrics: A rights issue impacts key financial ratios. For example, if there is no commensurate rise in profit, a new issue of shares will result in lower earnings and dividends per share. Furthermore, the company’s gearing ratio and return on equity would fall.
- Flags poor financial health: A large rights issue could signal major problems at the company, with fresh funds needed to stay afloat
- Unable to tap into debt: Empirical evidence suggests companies may conduct a rights issue if they are struggling to get access to the debt market i.e., they are financially constrained, or the management believe their share price has been overvalued by the market
- Near-term share price weakness: Rights are often priced comfortably below the latest share price to encourage investors to take up their rights (and therefore hand over cash to the company). Usually the company’s share price will gravitate towards the rights issue price as investors look to cash in on any arbitrage
