Magazine article New African

Rights or Scrip Issue, Which? It Is Important for Private Investors to Seek Expert Advice before Committing Themselves to Any Rights Issue. (NA Market)

Magazine article New African

Rights or Scrip Issue, Which? It Is Important for Private Investors to Seek Expert Advice before Committing Themselves to Any Rights Issue. (NA Market)

Article excerpt

Ordinary shares and non-voting shares are the main forms of equity capital, but there is a large number of ordinary equity shares as well, some are issued with the initial floatation of a company and others at subsequent dates.

There are several issue methods that are used when a company wishes to increase the number of shares in circulation. These include rights issue, scrip issue, offer for sale, placing and introduction.

Rights issue

A rights issue gives the shareholder the right but not the obligation to buy new shares in proportion to the number of shares he or she already owns in a company.

New shares are issued at a discount all the time (almost), and they are usually around 20%. In some countries (including the Commonwealth), the Companies Acts require that shares are offered to current shareholders before outside investors. Thus, existing shareholders have pre-emptive rights.

Let's assume that a company, ABC Ltd, is offering one new share at 400p for every four shares held. The current market value of the share is 500p. This is a l-for-4 rights issue. The owner of the 4 shares may purchase another at 400p.

In this case 5 shares are worth 2400p, the marker price, plus the additional subscription. The new price (also known as the "ex-rights price") will be 480p (2,400 divided by 5). Each right is worth 80p, (not 100p because the existing shares have been diluted in value).

The share price should theoretically fall to a level that reflects the weighted average of the old shares at their market price prior to issue, and the new shares at the rights issue price.

The above example implies that it is normal for prices of the new and old shares to be depressed during a rights issue, but most prices improve after the absorption of the issue.

The overall effect of the rights issue on the market price will be determined by the market reaction to a number of factors, including the stated reason for the capital raising, the amount and timing of this and the previous rights issues, and the outlook for the company.

An announcement that the issue is to be used for the profitable expansion should increase the demand for shares, thus increasing the market value. On the other hand, if a more cautious announcement is made, the market reaction might be to mark the price down.

It is therefore important for the investor to know that the share price would be affected by the use to which the funds are to be put, rather than the rights issue per se.

Rights issues are usually underwritten by a merchant bank. For a fee, the bank agrees to buy any shares not taken up by the existing shareholders. This would happen if the share price fell below the subscription price by the date of payment.

The advantage of pre-emptive rights is that it can prevent dilution of control for existing shareholders. Provided the rights are taken up and new shares are offered in proportion to existing shareholding, the existing shareholders will maintain the same level of control as before.

The advantage to the company of a rights issue is its low cost compared to a first issue. There is no requirement for a prospectus, and underwriting fees are nominal in comparison with new issues. A letter is simply sent to the shareholders with an offer and a deadline. …

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