What is a rights issue?

A rights issue is an offer to current shareholders to subscribe for new shares in proportion to their existing holdings. 

Companies use rights issues to raise additional equity capital, with new shares usually offered at a discount to the market price. Shareholders can accept the offer in full, in part, or reject the offer.

For example, assume you already own 100 shares in Company A. Shares in Company A are currently trading at $25. The company wants to raise money, so it announces a rights issue at $20 a share, with the offer open for 30 days. It sets a conversion rate of one for five. 

This means eligible shareholders can buy one additional share for every five shares they currently own. The result is you can buy 20 new equity shares for $400, a discount of $100 on the current market price. 

What is the impact of a rights issue on existing shareholders? 

Existing shareholders are typically offered new shares in proportion to their existing shareholding under a rights entitlement. This compensates existing shareholders for the potential dilution of their holdings resulting from increased outstanding shares. 

Dilution occurs because earnings and profits are spread over more shares. This can reduce earnings per share (EPS) and, therefore, dividends. 

Investors generally want earnings per share to increase since this means the company is making more profits. If a company has a higher number of shares on issue but no corresponding lift in profit, existing shareholders may choose to exit, and the value of the shares may fall. 

How do rights issues work? 

Let's look at an example. Say you are a current shareholder in XYZ Co and hold 100 shares in the company, each worth $5. XYZ Co wants to raise $12 million to pay down debt, so it decided to undertake a rights issue. 

It issues 3 million shares to existing investors for $4 a share. This is a 10-for-3 rights issue – for every 10 existing shares you hold in XYZ Co, you can purchase three new shares at the discounted price of $4 per share. This is a 20% discount on the price at which shares are currently trading. 

As a shareholder, you have the choice to:

• Buy 30 new shares at $4 a share
• Ignore your rights
• Sell the rights to someone else (provided they are renounceable). 

What is a renounceable rights issue?

Rights issues can be renounceable or non-renounceable. Shareholders can trade the 'rights' themselves in a renounceable rights issue. The rights are similar to share options in that they allow the holder to purchase a specified number of underlying shares at a specified price. 

In a renounceable rights issue, shareholders can 'renounce' these rights and trade them on the market. The value of a renounceable right is the difference between the market price of a share and the issue price of shares in the rights issue. 

The ASX conducts the market for the rights. The shareholder entitled to the rights can sell renounceable rights in the market. Trading begins on the morning of the ex-rights date and ends at the close of business on the rights trade cease date. The rights are traded on a deferred settlement basis until the day after the rights securities are dispatched to clients.

A renounceable rights issue enables shareholders to maintain proportional ownership in the company, provided they exercise their rights. The rights can also be sold, so shareholders can receive cash for their rights, if that is their preference. 

In a non-renounceable rights issue, the rights cannot be traded or sold. For this reason, shareholders often prefer renounceable rights issues. Nonetheless, companies may choose to conduct a non-renounceable rights issue when there is an urgent need to raise cash. 

Why do companies conduct rights issues? 

Rights issues enable companies to raise equity capital from existing shareholders to meet financing obligations or finance expansion. Proceeds from a rights issue can be invested in new assets or technology or used to fund an acquisition. 

Companies can also use the proceeds from rights issues to pay down debt, saving the interest expense of utilising debt capital. Depending on how the company uses the proceeds, they may eventually lead to increased capital gains for shareholders, despite dilution. 

Which ASX companies have conducted rights issues? 

Many major ASX companies have conducted rights issues. In 2022, various ASX companies completed rights issues to fund acquisitions, restructure debt, and bolster their balance sheets. 

Atlas Arteria Group (ASX: ALX) conducted a 1 for 1.95 non-renounceable rights offer to raise $3,098 million to fund its acquisition of a 66.67% interest in the Chicago Skyway toll road. 

Domain Holdings Australia Ltd  (ASX: DHG) conducted a 1-for-12.33 non-renounceable rights offer to raise $180 million needed to acquire Realbase Pty Ltd, a real estate campaign management technology platform. 

Regal Partners Ltd (ASX: RPL) conducted a 1-for-5 non-renounceable rights issue to increase the free float and shareholder base and fast-track the execution of its diversified growth strategy. 

Healthia Limited (ASX: HLA) conducted a 1-for-12.5 non-renounceable rights issue to provide additional cash reserves to fund near-term acquisition opportunities and provide financial flexibility. 

GUD Holdings Limited  (ASX: GUD) conducted a 1 for 3.46 non-renounceable rights issue in conjunction with an institutional placement in late 2021, raising $405 million to acquire AutoPacific Group, a designer and manufacturer of automotive and lifestyle accessories. 

What are the pros of a rights issue?

• Increase investment at a discount:  Conducting a rights issue enables current shareholders to increase their investment in a company at a discounted cost. Whether this increase in exposure is ultimately good or bad will depend on how the company performs. 
• Source of capital: For companies, rights issues can be a valuable source of equity capital but can also be risky. Shareholders may not want to buy more shares, especially if growth has slowed. 

And the cons?

• Reduced EPS: The increased number of shares on issue following a rights issue means earnings per share will fall (all else being equal). This puts downward pressure on the share price. 
• Dilution: If shareholders do not take up their rights in a rights issue, their shareholding will be diluted. 
• Market interpretation: Depending on the circumstances, the market may also interpret a rights issue as a sign that the company is struggling. This could be the case where, for example, the rights issue is being conducted due to unavailable debt capital. 

Should you participate in a rights issue?

Participating in a rights issue will depend on the terms and circumstances of the issue and your financial situation and expectations. It may be tempting to acquire additional shares in a company you hold at a price below market, but this does not automatically mean you are bagging a bargain. 

The purpose of the rights issue is important – there should be a compelling reason why the rights issue is necessary for the company's strategic plans. 

If you have a positive outlook on the company, you may wish to participate. If you do not have a positive outlook, you may prefer to invest elsewhere.