FT has been trading full time from home for four years, with nothing but four kids and a beach to distract him .
He fills his spare time with weight training and rugby, though more coaching than playing these days.
FT mostly trades the forex markets and although he plays FTSE on occasions his bread and butter market is £$.
He likes to think that his technique is evolving but still hasn’t the temperament or money to back the big calls. He prefers to trade between 1 and 3 times a day, aiming to take regular small gains, but feels part of the evolution is in not dealing if the conditions don’t feel right.
What Is A Rights Issue?
Rights Issues are common place in the financial markets these days. But what is a rights issue? What does the term mean and what impact does it have on shareholders and share prices?
What’s A Rights Issue?
It’s a polite way of asking shareholders for more dosh. It’s polite because there are other ways of raising money (issuing corporate bonds or selling shares to an individual ‘benefactor’), but this way gives shareholders the chance to be involved.
A rights issue is a way in which a company can raise money by selling new shares. These shares are offered to existing shareholders in proportion to their current shareholding, but at a much cheaper price than the current market price.
“Wa hey!” says you, “I thought there was no such thing as a free lunch; this looks pretty close to me.”
‘fraid not pal. I’ll save the full maths lesson for another day, but trust me on this. Freebies from the City are usually limited to pens, mouse mats and stress balls. Although you get these shares ‘on the cheap’ those nasty guys in the City will adjust (mark down) the price of your existing shares to take account of all this, a sort of robbing you to pay you.
If you take up the rights your holding will remain the same in percentage terms. But here’s the rub; if you don’t take up your rights, your original investment will be worth less, though you can sell the rights to make up some, or all, of the loss. Not so wonderful now then.
Rights issues can be launched from a position of strength; a company doing well might need further capital to fund a new venture, expansion or a strategic takeover. Alternatively, companies also launch rights issues from a position of weakness, for example, if it needs extra funds after suffering losses or a deterioration in its balance sheet. Unfortunately the banking sector falls into the second category. For a bit of background check out my earlier piece on rights issues.
Underwriters – The Ones Closest To A Free Lunch
When the company bosses decide to ask its shareholders to have a whip round, they’ll phone the investment banker that took them to the sport at Leopard’s Town/ Twickenham/ St Andrews and ask him to set the ball rolling.
The investment banker gets on well with all the top institutional shareholders (who also get taken to Leopard’s Town/ Twickenham/ St Andrews). He and his team will then play investment poker with shareholders to arrive at the best price they can sell the new shares at. He needs to judge the appetite for the extra shares, and balance the highest price he can sell the rights at with the risk that he might be left with unwanted shares if the price is too high.
The investment bank will underwrite the rights issue. In normal language that means they’ll guarantee that the company will receive full payment for all the shares; they’ll buy any shares not wanted by existing shareholders. And for doing this they’ll get paid an astronomical multiple of the Leopard’s Town/ Twickenham/ St Andrews ticket price.
But here’s the clever bit; the investment bank doesn’t want the risk of holding unwanted shares. So they offer the underwriting commitment to other organisations in exchange for a part of their massive fee. In the good times this is a real gravy train; it’s money for old rope as rights issues are priced to go. But once in a while the underwriters have to earn their fees and take the unwanted shares.
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April 15th, 2009 at 10:35 am
Is’n there any risks on the Trading Rights Issues ?
June 9th, 2009 at 7:55 pm
Does this mean that the underwriter can (and in fact, does) pre-sell (or pre-committ) some of the anticipated excess rights shares to other buyers (underwriters) at the new rights issue price?
June 18th, 2009 at 5:39 pm
Hi dan, sorry mate your post went under my radar. what the underwriter does is to sub-underwrite the shares (he offloads the risk). Taking a hypothetical example, if say, Barcloyds was arranging a rights issue for XYZ plc, they would guartantee the XYZ would receive the proceeds from the sale of the whole issue. Barcloyds would then get rid of the risk by offering institutional clients like Illegal & General or JPM Asset Management the chance to underwrite x shares at the rights price. They would only get these if the issue wasn’t fully taken up and would get a payment for their troubles, regardless of whether they get the shares (an underwriting premium).
It used to be easy money for the institutions and the chance to sometimes pick up some cheap shares, but once in a while they’d get hit with some Duff stock (that’s probably in your pension fund now!).
Hope that helps.
September 24th, 2009 at 11:13 am
I am totally confused.If you do not have the money to buy shares that are offered at a reduced price, will you just loose money as the share price falls. Would it not be better to sell your shares and re-invest when the shares drop and make a larger profit long term
September 24th, 2009 at 5:04 pm
Hi Debbie,
doesn’t sound like you’re confused at all. Yes, if you can’t take up the rights (at the lower price) you’ll loose out if the share price falls. The way around that is to sell part of your existing holding to fund the take up the cheaper shares.
Unfortunately the market isn’t a charity so it’ll mark down the price to stop everyone selling their shares and buying them back cheaper later on-there are few easy profits in this game. Hope that makes sense.
What markets do you trade?
September 27th, 2009 at 6:58 am
What are the tax implications for the shareholders who take up the rights at discounted price?
September 28th, 2009 at 9:51 am
Sorry Sandeep, this comes under the category of ‘I’m unable to advise on tax issues’ .
October 26th, 2009 at 2:44 pm
When you speak about shares “offered to existing shareholders in proportion to their current shareholding”, do you mean one-for-one?
October 26th, 2009 at 3:40 pm
Hi Stephen,
no, it doesn’t have to be 1 for 1. These days investment bankers try to justify their high salaries by creating stranger ratios like 2 for every 5 held or 5 for every 17 held. These numbers depend on lots of variables like how much the company needs to raise, how ‘cheap’ the rights need to be and the effect of the discount on the existing share price.
Hope that helps
October 29th, 2009 at 9:55 am
Re: LLoyds tsb (LBG) proposed RI
Iam in to lbg for nearly 3.00 down from 4.00 on the last day of the Open Offer the shares traded at 120 then dropped into 60’s when 78p was the breakeven after the OO. So I would have been better off not taking up the OO and buying in the low 60’s as it took ages to reach the breakeven 78p.
Question is would I be better off waiting for the price to rise close to the ex RI date (assuming it will) and buying back once the price has been diluted ? or there other options as I dont have the funds to take up the offer and dont want my percentage to drop.
Thank you
Mark.
October 29th, 2009 at 10:31 am
what practical process would a company use to raise capital or rights issue
November 10th, 2009 at 4:45 pm
Hi mark,
I’m guessing this is all hypothetical now as the Lloyds thing was done and dusted way back. To be honest I don’t worry about my percentage dropping in these instances. I shorted lloyds ahead of the issue and took up my rights. To be honest the lloyds short was adjusted for the offer and made a bit but not much.
If you don’t have funds, or don’t wish to put more money into the co you can usually sell part of the rights to fund the take-up of the balance. In terms of whether to sell beforehand and buy ex, rather than take the entitlement, it’s a market call, but bear in mind the OO shares come to you free of stamp duty and commission, so that’s worth a bit.
November 10th, 2009 at 4:50 pm
Damn, I said ‘to be honest’ twice there; I never trust anyone who says that!
November 10th, 2009 at 5:00 pm
Hi emma,
massive question; short answer.
Company would pay an investment bank several millions of ££s to advise them on whether to raise capital by issuing debt (corporate bonds) or equity. Both have fors and againsts but would take into consideration the company’s credit rating, the overall cost of capital and the company’s tax position. Also debt might require more onerous covanent restrictions.
The rich investment bank would sound out the big investment houses to judge the price they’d be interested at and ‘build a book’ of takers. A rights issue differs as generally existing holders get a pro-rata offer of new shares.
The Inv bank will underwrite guarantee) the issue and offload all/part of that risk to investment houses (all for a fee of course).Any leftover bonds or shares are taken up by the underwriters; if there isn’t any leftover , they still get their fat fee.
hope that sheds some light.
November 17th, 2009 at 5:46 pm
what about the situation where the proposed (already announced) rights issue price/or stock price is higher than the current stock price? does that happened often? under what circumstance does that usually happen? and what usually happens to the stock price afterwards? by the way, the rights issue is fully underwritten..
thanks much
peter
November 18th, 2009 at 10:32 pm
So….
Will lloyds share price crash next week….????
November 25th, 2009 at 10:10 pm
Can you explain this option for me? Iam struggling to get my head around this
4 Fund the take up of the Rights by selling some of your QUINTAIN EST & DEV Nil Paid Rights.
If you wish to sell some of your Rights in this way, the following conditions will apply:
We will sell sufficient Rights to take up the Rights on the remainder.
Your Nil Paid Rights will be sold on the next working day after we receive your instruction and will be based on your holding of Nil Paid Rights at that time.
A contract note will be available confirming the sale details
We may aggregate your sale order with orders from other QUINTAIN EST & DEV shareholders opting to sell QUINTAIN EST & DEV Nil Paid Rights; this may result in a slightly more or less favourable price than a sale of your Rights alone. The price obtained will be the best price available at the time we execute your deal in the market.
Our standard dealing charges will apply
The remaining Rights will be taken up under the terms of the Rights Issue.
November 26th, 2009 at 11:16 am
Hi Peter, I’ve never heard of a case where the rights issue price is higher than the current share price. It would be quite strange for that to happen as more shares are being offered in a rights issue so there is share dilution. As a rights issue is normally quite a desperate measure, the price is usually discounted significantly. Finance theory would say that the share price should fall to take into account of these discounted shares. In the real world, it doesn’t work that smoothly, but you still wouldn’t see a case where the rights issue price is higher than the current share price.
In stocks merges and share repurchases, the share price does tend to rise as there are fewer shares outstanding. They are the opposite of rights issues.
After the rights issue is over and the share price has been fully discounted, anything could happen to the share price. For example, in the recent Lloyds case, Lloyds share price may now recover as they have a much stronger capital base to rebuild from. Or they might struggle, their new capital may be eroded and they may have to be nationalised. Anything could happen after the rights issue is complete.
To continue with your question Denver, Lloyds share price has initially reacted quite well to their rights issue as the issue was well bid so Lloyds were able to charge a higher price for the new shares. It doesn’t always work that smoothly, especially in a desperation measure like a rights issue. For example, in both the Bradford & Bingley and RBS rights issue, even though they were deeply discounted, the market didn’t want anything to do with them. The shares weren’t taken up. Bradford & Bingley went bust and the UK government was left with a much larger RBS stake than they wanted.
November 26th, 2009 at 2:11 pm
thanks for the reply. i was confused as well as to why the proposed rights issue carry a premium to the stock price (in this case, it was 0.54 before the announcement, and the proposed rights issue price is 0.60; and the current price is around 0.60).
there is one additional detail: the underwriter is actually the financing arm/subsidiary of the #1 shareholder of the company (currently has 47%).
there are two scenarios i can think of: 1) the #1 shareholder wants to shore up the stock price and thinks the premium will create trendmendous boost to the confidence of shareholders and therefore stock will go up after the announcement, and the premium will be no longer there after the stock goes up; 2) the #1 shareholder wants to increase his % holdings in the company and the premium will discourage subscriptions from other shareholders, and since he is underwriting it, he would increase his share when other don’t participate.
does the scenarios i mentioned make any sense at all? trying to figure it out….
thanks much
peter
November 26th, 2009 at 2:52 pm
That’s an interesting and strange situation. What company was doing the rights issue? In this situation that second scenario you outlined looks very plausible. It seems the number one shareholder was looking for a backdoor and sneaky way of getting over 50% of the shares and therefore control of the company. As a control premium is worth a bit (difficult to quantify how much), the number one shareholder would be willing to pay more per share, in this case, 0.06 more. For the other shareholders to stop him from taking over, they would have to pay 0.06 a share extra. Some would be willing to do that, both many others wouldn’t have had the cash or desire to do it. Sounds sneaky, but very plausible. An interesting case study.
November 27th, 2009 at 2:35 am
thanks for the reply.. it is a small chinese company listed in hong kong doing the rights issue..
November 27th, 2009 at 9:47 am
Can you buy the rights issue shares on the stock exchange instead of taking them up with the company issuing them?
Can you buy more than your entitlement from the stock exchange?
What happens to the rights issue shares sold on the stock market?
I am referring to the Lloyds RI shares which are currently trading at 24p, whereas Lloyds are offering them at 37p.
November 29th, 2009 at 9:49 am
I am confused and very ignorant. I’ve inherited some shares from my husband and have been offered a rights issue which I don’t want to take up due to cost. However, if I sell all my rights, surely any premium obtained would go to the company and not to me as they are the ones selling the shares.
December 7th, 2009 at 2:51 pm
Hi Sandeep, some useful info about the tax treatment of rights issues http://timetotrade.eu/wiki/index.php/Right_Issues_&_Open_Offers
December 17th, 2009 at 11:47 pm
Can all the rights issued traded on the market? Or depending on the terms by the issuing company?
Thanks!
Wing