Rights offers can be a strategic opportunity for shareholders if they align with their investment goals and the company’s prospects. But not all rights issues are good. This article discusses key factors you must analyze before subscribing to rights shares, such as the company’s financial health, the purpose of the rights shares offered, and your own investment strategy.
A rights issue of shares allows investors to buy additional shares at a discounted price and potentially enhance their investment value if the funds are used effectively. However, if you choose not to apply, the ownership percentage may be diluted.
What is a Rights Issue?
Rights issue is an offer to existing shareholders to buy more shares of a company in proportion to current holdings, usually at a discounted price. Companies fix a record date to decide shareholders' eligibility to participate in rights offers. Anyone who held the company’s shares in a demat account on the record date is eligible.
Quick Example of Rights issue:
- Current market price: Rs 100
- Rights issue price: Rs 85
- Rights issue entitlement: 2:5
- Record date: 10 April
Let’s say you hold 200 shares on the record date:
- You’re eligible to buy 100 rights shares at Rs 85/share
- Average holding cost (if you subscribe): [(200 × 100) + (100 × 85)] / 300 = ₹95
- Total shares: 300
- Total Investment post rights issue apply: Rs 28,500
Key Features of Rights Issue
- Rights issue of shares is an invitation to buy additional shares of the company.
- Rights shares are offered in proportion to the current shareholding.
- Rights shares are generally offered at a discount to the current market price (CMP).
- Investors can choose to apply for rights shares or let it go. Check process.
- Companies credit rights entitlement (RE), temporary shares to eligible shareholders which they can use to apply for rights shares.
- Investors who don’t want to subscribe can sell their RE on the stock exchange.
How to Buy and Sell Rights Entitlement?
Should You Subscribe to Rights Shares? Ask Yourself These 5 Questions:
1. Why is the company offering rights shares: Know the Objective
Well, raising funds is the primary objective of offering a rights issue of shares. A company can consider offering rights shares for various purposes – pay-off debts, expansion, growth, etc.
First, understand the reason behind fundraising via rights offer. When a company is raising funds for business expansion or acquisition, debt repayment for capital restructuring, it can be good sign.
But when rights shares are offered by financially stressed companies to cover operational losses or strengthen balance sheet, it can be a red flag. So make sure to know the fundraising objective.
Investor Tip: Check out rights issue letter of offer documents for the “Objects of the Issue” section.
2. Is the offer price Attractive?
As said, rights shares are offered at a discount to the current market price but it doesn’t mean that all rights issues are worth subscribing for.
Being an eligible investor, you should first compare the price offered for rights shares with the CMP (current market price) to assess whether the price offered is attractive or not.
Rights shares offered at a deeper discount may be a sign of higher risk – but also more upside potential, if the company performs well.
3. Company’s Financial Performance
Analyzing the company’s financial performance is key. Check factors like:
- How well the company is performing, is it growing?
- Is the business revenue increasing at a decent rate?
- Is it generating good profits and cash flows?
- Does company’s management have a good track record?
Financial performance of the company will help you have an idea about company’s future performance. And if the company is expected to perform well in future, it is worth subscribing for rights shares.
But if you see any red flags in recent earnings or see continuous fall in stock, it might be better to let it go.
So, make sure to check the company’s key financial metric before participating in rights shares.
4. Check Your Liquidity and Risk Appetite
Applying for rights shares requires upfront money. So ask yourself few things:
- Do you have liquid funds to purchase more shares (rights shares) in the same company? Don’t stretch yourself just for a discount.
- Are you overexposed to the company’s shares already?
If you have the capital and strongly believe in long-term growth potential, you can subscribe rights shares.
5. Is the dilution of shares is a concern for you?
As rights shares are offered proportionally to your existing shareholdings, it does not dilute your stake as you can buy proportionate shares.
But what if you are not interested? Well, if you don’t subscribe for rights shares, it results in equity dilution and your shareholding percentage goes down.
Well, equity dilution from rights offering may be a significant concern for big investors who are having substantial stake in the company. If large investors choose not to subscribe, their ownership percentage and consequently voting power, and EPS – can diminish.
Equity Dilution in Rights issue – A concern for large investors because of the following reasons:
- Loss of control over company decisions
- Per-share metrics like EPS and stock price can decrease.
- If a rights issue is perceived as a sign of financial distress, shares price may decrease sharply.
What happens if you don’t subscribe rights shares?
- Miss out an opportunity to buy more shares at a discount
- Your ownership gets diluted
- Rights issue may decrease share prices post-issue.
Important Tip: If you don’t subscribe for rights shares, you can sell your rights entitlement (RE) in the market. Yes, REs are traded on the exchange.
Pros of Subscribing Rights shares
- Average down your holding cost per share.
- Buy more shares of the company at a discounted price
- Avoid dilution of ownership
- Potential for long-term gains
Cons of Subscribing Rights shares
- Post-issue selling prices might drag stock prices down
- Your capital may tie up in risky businesses.
- May be a risky bet, if the company does not perform well.
Final Verdict: When to Subscribe Rights Issue of Shares?
Don’t subscribe rights shares just because it is cheap. You should apply for rights shares, only if…
- Company has solid financials, and the purpose of fundraising is to growth-focused
- Management have a solid track record and you trust them
- You want to maintain or increase your stake without any financial strain
Do not subscribe rights issue, if…
- Weak financials or poor management
- Unclear use of funds to be raised through rights issue
- You’re already overexposed to the stock
- You don’t have strong conviction in the company’s future growth
Want to participate in rights offer but don’t know how? Check out the step-by-step guide on how to apply in rights shares?
