Raising Equity Capital

Seasoned Equity Offerings: Rights Issues

Features of rights issues:
 Only listed companies use this method
 One ‘right’ is issued for each outstanding share.
 Right is an option to buy new share(s) from the company.
 Right price is lower than market price (why?)
 The right expires on a specified date.

Shareholders can:
(a) Subscribe the shares using rights, or
(b) Sell the rights in the market, or
(c) Do nothing.
 Terms of Rights Issue

Always one ‘right’ is given to the holder of a share. How many new
shares should be issued (NS) to raise funds required?
Funds required
NS =
Subscription Price (PS)
How many rights (NR) are required to buy a new share?

Number of old shares outstanding (N0)

NR =
NS

Total value of rights required to buy a new share (TVR): =

Ex-right price (PX) – subscription price (PS)
Or, value of a right (VR) = (PO) – (PX) [where PO = Pre-issue price]
What should be the ex-right price (PX) of a share? Note: Value of a
right = TVR/NR, or
(PO – PX) i.e. VR
 Rights Issues and Price Adjustment

( P0* NO)  ( PS * NS )
PX(ex right price) 
NO  NS

Pre issue price (PO)

P0 Ex-right price (PX)
Px

Total value of rights required to

PS buy a new share (VR)

Subscription price (PS)

Time
Close of offer date
 Wealth Effect of Rights Issue
Mr Lam holds 10 shares of Surya Ltd priced at £30 each. Therefore, the value
of his holdings is £300. Mr Lam receives 10 rights which allows him to
subscribe a new share at £20. You are required to estimate:
(a) Ex-right price (PX)
(b) value of one right (and total value of rights, VR)
(c) wealth effect, if Mr Lam decides to subscribe to the offer
(d) wealth effect, if Mr Lam decides to sell the right

Terms of offer:
Subscription price (PS) £20
Number rights 10
Number of rights needed to buy a share 10
 Wealth Effect of Rights Issue
Mr Lam decides to subscribe. Then:
Number of shares held (10+1) 11
Value of Investment (£300+£20) £320
Price per share (£320/11) £29.09 (approx)

Value of one right: Old share price – New share price £0.91 (approx)

Mr Lam decides to sell the rights. Then

New value of 10 Shares 290.90
Proceeds from the sale of 10 rights (10 x 0.91) 9.10
Total value £300.00

Rights issue does not affect the wealth of a shareholder.

 Rights Issue: Morfa Plc
Morfa plc has grown rapidly over the last few years and has funded its growth
by borrowing heavily. It has achieved a high rate of return on capital
employed and with a high level of gearing has produced even higher returns
for its shareholders. It is anticipated that the company will need to raise more
funds externally over the next few years to finance its capital expenditure.
The board of directors have recognised that the company cannot increase its
debt-equity ratio further. It has been decided to reduce its debt-equity ratio,
so as to provide the possibility of further borrowing in subsequent years. On
this basis the board of directors has decided to undertake a rights issue to
raise £480 million. The company’s shares are trading at £1.50 and it is
proposed to make the rights issue at a discount of 20 per cent to the current
price. The company’s investment bank sees no problems in raising the funds
required but it has been decided to have the issue underwritten. The
company has 800 million shares outstanding giving its equity a market value
of £1200 million.
 Rights Issue: Morfa Plc
(i) Determine the terms of the issue, the expected ex-rights price of a
share, and the value of a right.

Current Share Price P0 1.50

Number of Shares Outstanding N0 800
Value of Company (Pre-issue) V0 1200
Funds Required F 480
Discount (%) D 0.20
Subscription Price (20% discount on current price) PS 1.20
Number of Shares to be Issued (480/1.20) ΔN 400
Terms (New shares/ Old shares 400/800 =0.5; i.e. 2 rights
are required to buy a new share) 0.50
Ex-Rights Price (1200+480)/(800+400) PX 1.40
Value of each Right (PO – PX, 1.50 – 1.40) VR 0.10
 Rights Issue: Morfa Plc
(ii) Demonstrate that in principle a shareholder, holding 300 shares, will be
equally well off from investing in the new shares or selling his or her
rights.

Investor Takes Up the Rights Investor Sells Rights

Initial Investment Initial Investment
Value of 300 Shares held @ P0 £450 Investor Owns x Shares at P0 £450
Investor subscribes to Issue PS £180 Investor Sells Rights (300*0.10) -£30
Total Investment £630 Adjusted Value of Investment £420

Value of Shares at PX = £1.40 Value of Shares at PX

(300+150) =450*£1.40 £630 (300*£1.40) £420
Impact on Wealth of Investor Zero Impact on Wealth of Investor Zero