FINANCIAL MANAGEMENT-II

GROUP ASSIGNMENT:
• RIGHT ISSUES
SUBMITTED BY:
ARUN KUMAR (09CB05)
BALACHANDAR.C (09CB06)
JINCY ALEXANDER (09CB12)
KRITHIKA.D (09CB13)
NIRMALA.C (09CB16)
VASANTH.S.S (09CB21)
SUBMITTED TO:
Mrs. GOKILA VANI

RIGHT ISSUES-INTRODUCTION
SHARE CAPITAL
Historically, companies have had two kinds of share capital.

Authorised is the share capital the company has created and the maximum it
can issue. A company with a £1m authorised share capital may, for example,
have 10 million authorised shares of 10p each.

Issued is the share capital issued and held by shareholders. It may be all 10
million shares in the above example, or only nine million, leaving one million
authorised but unissued.

From October 2008, however, the Companies Act 2006 does away with the
requirement for authorised share capital, leaving just the shares that have
actually been issued.

SHARE VALUES
A share will have a nominal or par value: 1p, 10p, £1 or any other sum in any
currency. And it is an absolute rule that a share cannot be issued fully paid for
anything less than its nominal value – that is, it cannot be issued at a discount.
A company cannot issue a £1 share fully paid for 99p or less. A company thus
has no ability to issue free shares (but it may buy shares in the market and give
them as free shares to employees, say, as part of an incentive scheme).

A company is able to issue shares nil or partly paid. That means it can issue a
£1 share nil paid and take no money for it on issue; or it may issue the share
partly paid, say as to 25p. The amount unpaid (the full £1 or the balance of 75p)
remains due and will have to be paid when the company calls for payment at a
time anticipated in the terms of the share’s issue, or on a winding up if the
company’s assets are not enough to settle its liabilities.

Of course, a £1 share will often be issued with a price being paid to the
company well in excess of that sum; the difference between the nominal value
and the price paid is the premium. The directors are under a duty in issuing
shares (as in all things) to act in the best interests of the company, and if a £1
share has a market value of £1.50, they must have a good reason for issuing it
for anything less than £1.50. The nominal value is only the minimum price at
which shares can be issued.

DIFFERENT CLASSES OF SHARE

Unless the articles say otherwise, all shares will rank equally. But to the extent
they are given different rights – to dividends, to a return of capital on winding
up and on voting – they will comprise different classes of share. A company
may have one class of share or it may have many.

Ordinary shares are the basic building block of a company’s share capital.
They will carry votes (usually one each), have a right to a dividend if the
directors decide to pay one, and also be entitled to share in any surplus on a
winding up of the company. Other shares will take their rights, or lack of them,
by reference to this base position. Non-voting shares are self-explanatory (and
a rarity these days, generally shunned by investing institutions but favoured by
companies with a substantial family shareholding – for example, Daily Mail and
General Trust). Preference shares may have a preferential right to a dividend
ahead of the ordinary shares, or to a return of capital, or both. Deferred shares
will rank behind the ordinaries (and tend to be used in a capital reorganisation
where there is a need to make the shares virtually valueless).

Where these different classes of share exist, the rights of each one can only be
changed in line with requirements in the articles or, if they are silent,
requirements in the Companies Act. The articles will commonly stipulate a
certain level of consent to any change; in default, the Act requires the holders of
75 per cent in nominal value to consent in writing, or holders of shares of that
class to pass a special resolution (see our OUT-LAW guide to Company
meetings) approving the change at a separate meeting. Outside investors in a
non-listed company may often expand the definition of what amounts to a class
right and so prevent certain acts of the company (for example, the payment of a
dividend) without their prior consent.

SHARE ISSUES
Directors cannot issue newly created shares without shareholder authority to do
so. Two provisions of the Companies Act 1985 are key here and will be familiar
from any listed company AGM notice:

Section 80 stops the directors from issuing shares to anyone unless they are
authorised to do so in the articles or by shareholders passing an ordinary
resolution. This ban includes an agreement to issue shares and the grant of
options that will result in a future issue of shares (although employee share
schemes are exempt). Listed companies will ask shareholders to give them this
authority each year at the AGM, but will have to respect certain limitations
stipulated by institutional shareholders – the rule has been that only 15 per cent
of the authorised share capital can be issued – and the authority has to be
renewed at each AGM.

The Companies Act 2006 replaces this in October 2008 with new sections 549
and 551, and the restriction will no longer apply to a private company with only
one class of share.

Section 89 obliges a company to offer new shares first of all to its existing
shareholders in the same proportions they already hold shares. In other words, it
upholds shareholders’ right to be protected from dilution. If they are willing to
pay the price asked for the new shares, they can have them. But this only
applies where the shares are offered for cash – if a company is issuing shares in
exchange for shares in another company, say, or in payment for a non-cash
asset, there is no requirement to offer the shares to existing shareholders first of
all.
The section can be disapplied, along with section 80, either in the articles or by
a shareholder vote, though only by a special resolution. These rules are repeated
in the Companies Act 2006 (section 561 and following).

Again, institutional shareholders have their price: only shares equal to five per
cent of the issued share capital can be issued without first offering them to
shareholders.

RIGHTS ISSUES AND BONUS ISSUES

A rights issue is a common way for a company to raise fresh capital: it issues
new shares, offering them first to existing shareholders. Indeed, section 89,
discussed above, obliges a company to treat any issue of shares for cash as a
rights issue unless the shareholders have first agreed otherwise. (A rights issue
for a listed company will often not follow the section 89 procedure because of
various practical difficulties and the additional requirements of the Listing
Rules.)

A listed company rights issue will usually offer shares at a discount to the
current market price, sometimes a heavy discount if the shareholders’ appetite
for the shares needs to be stimulated. That discount means that there is an
inherent value in the right to be offered the shares, and the shareholders in a
listed company can trade those rights and realise that value if they do not want
to take up the shares themselves.

Alternatives to a rights issue include an open offer where shareholders are

invited to subscribe to a number of new shares based on their proportionate
entitlements. This can be less complex than a rights issue but it does not give
shareholders the opportunity to trade their rights to take up shares and so benefit
from the discount. A vendor placing may also be used where one company is
buying shares in another. Shares are allotted by the purchaser to the sellers of
the target but the purchaser’s investment bank agrees to find investors or
placees who will take those shares and so give the sellers cash. Institutional
shareholders of the purchaser may insist on a clawback whereby those shares
are first offered to them in proportion to their existing holdings.

A bonus issue involves no new money. Also called a capitalisation or scrip

issue, it takes a sum from the company’s reserves (distributable profits that
could be used to pay a dividend or the share premium account) and capitalises it
by using it to pay for the new shares. The issued share capital is increased
without any new money being invested. The new shares are issued to existing
shareholders pro rata to their shareholdings and so no dilution occurs.

ISSUE OF RIGHTS
An issue of securities to the existing shareholders with the right resting on the
investor either to accept or reject the offer.

A corporation/company usually offers a rights issue to the existing shareholders

an option to buy new shares of the company at a predetermined price usually at
a discount to the existing market price in a pre fixed ratio.

A rights issue will be of the form, issue of x number of shares to the existing
shareholders at a price of y per share in the ratio of n shares for every y shares
held as on date D.

A rights issue has the following effects on the price of a stock.

1. Share capital gets increased according to the rights issue ratio.

2. Liquidity in the stock increases.
3. Effective Earnings per share, Book Value and other per share values stand
reduced.
4. Markets take the action usually as a favorable act.
5. Market price gets adjusted on issue of rights shares.
6. Company gets better cash flow which may be used to improve the business
and may help increase effective Earnings per share.
7. Usually a shareholder may not back out from applying for the rights issue
unless the offer is almost same as the prevailing market price. This is because if
a stock is trading at 100 and a rights issue in the ratio 1:1 at a price of 40 will
make the stock trade at 70 soon after the ex-rights date.

Three things to note about right issues are:

Shares are issued to existing shareholders
Shares are issued in proportion of shareholders current shareholdings
Shares are often priced at a discount

HOW IT WORKS
A rights issue is directly offered to all shareholders of record or through broker
dealers of record and may be exercised in full or partially. Subscription rights
may either be transferable, allowing the subscription-right-holder to sell them
privately, on the open market or not at all. A right issuance to shareholders is
generally issued as a tax-free dividend on a ratio basis (e.g. a dividend of one
subscription right for one share of Common stock issued and outstanding).
Because the company receives shareholders' money in exchange for shares, a
rights issue is a source of capital.

Typically, a rights issue is expressed as 'one for nine' or 'one for six'.
What this means is for every nine (or six) shares you already own, the company
will offer you one more at the special price. You can sell the rights (or even
allow them to lapse) rather than take them up, but if you don't take them up your
shareholding in the company will be diluted (because new shares are being
issued).

Options available to existing shareholder:

Right issue as the name suggest is a right to buy more ordinary shares in the
company as an existing shareholder, but such right issue, though it is a right it is
not an obligation, this means existing shareholders do not need to take up the
right (shares) especially when the share price dips lower than the right issue
price by the time the share needs to be taken up.

There are broadly four (4) main options available to existing shareholder
such as:
Buy all … the shareholder takes up all the right issue shares and keeps it.
Sell all … the shareholder takes up all the right issue shares, and subsequently
sells all the right shares.
Buy part; sell part … the shareholder takes up all the right issue shares with
the intension of keeping part and selling the remainder.
Do nothing … the shareholder does not take up the right issue shares at all,

CONSIDERATIONS
Issue rights the financial manager has to consider:

• Engaging a Dealer-Manager or Broker Dealer to manage the Offering

processes

• Selling Group and broker dealer participation

• Subscription price per new share

• Number of new shares to be sold

• The value of rights vs. trading price of the subscription rights

• The effect of rights on the value of the current share

• The effect of rights to shareholders of record and new shareholders and

right-holders

UNDERWRITING
Rights issues may be underwritten. The role of the underwriter is to guarantee
that the funds sought by the company will be raised. The agreement between the
underwriter and the company is set out in a formal underwriting agreement.
Typical terms of an underwriting require the underwriter to subscribe for any
shares offered but not taken up by shareholders. The underwriting agreement
will normally enable the underwriter to terminate its obligations in defined
circumstances.

A sub-underwriter in turn sub-underwrites some or all of the

obligations of the main underwriter; the underwriter passes its risk to the sub-
underwriter by requiring the sub-underwriter to subscribe for or purchase a
portion of the shares for which the underwriter is obliged to subscribe in the
event of a shortfall. Underwriters and sub-underwriters may be financial
institutions, stock-brokers, major shareholders of the company or other related
or unrelated parties. The Panel’s guidance covers both non-underwritten and
underwritten rights issues.

Other factors to consider in rights issues

In addition to the price at which a rights issue is offered, there are several other
factors that need to be considered:

Issue Costs:

Rights issues are a relatively cheap way of raising capital for a quoted company
since the costs of preparing a brochure, underwriting commission or press
advertising involved in a new issue of shares are largely avoided.

However, it still costs money to complete a rights issue. Issue costs are often
estimated at around 4% on equity funds raised of around £2 million raised.
However, as many of the costs of the rights issue are fixed (e.g. accountants and
lawyers fees) the % cost falls as the sum raised increases.
Shareholder reactions:

Shareholders may react badly to firms continually making rights issues as they
are forced either to take up their rights or sell them. They may sell their shares
in the company, driving down the market price

Control:

Unless large numbers of existing shareholders sell their rights to new

shareholders there should be little impact in terms of control of the business by
existing shareholders

Unlisted companies:

Unlisted companies often find rights issues difficult to use, because

shareholders unable to raise sufficient funds to take up their rights may not have
available the alternative of selling them where the firm's shares are not listed.
This could mean that the firm is forced to rely on retained profits as the main
source of equity, or seek to raise venture capital or take on debt.

BASIC EXAMPLE
An investor: Mr. A had 100 shares of company X at a total investment of
$40,000, assuming that he purchased the shares at $400 per share and that the
stock price did not change between the purchase date and the date at which the
rights were issued.

Assuming a 1:1 subscription rights issue at an offer price of $200, Mr. A will be
notified by a broker dealer that he has the option to subscribe for an additional
100 shares of Common stock of the company at the offer price. Now, if he
exercises his option, he would have to pay an additional $20,000 in order to
acquire the shares, thus effectively bringing his average cost of acquisition for
the 200 shares to $300 per share ((40,000+20,000)/200=300). Although the
price on the stock markets should reflect a new price of $300 (see below), the
investor is actually not making any profit nor any loss. In many cases, the stock
purchase right (which acts as an option) can be traded at an exchange. In this
example, the price of the right would adjust itself to $100 (ideally).

The company: Company X has 100 million outstanding shares. The share price
currently quoted on the stock exchanges is $400 thus the market capitalization
of the stock would be $40 billion (outstanding shares times share price).

If all the shareholders of the company choose to exercise their stock option, the
company's outstanding shares would increase to 200 million. The market
capitalization of the stock would increase to $60 billion (previous market
capitalization + cash received from owners of rights converting their rights to
shares), implying a share price of $300 ($60 billion / 200 million shares). If the
company were to do nothing with the raised money, its Earnings per share
(EPS) would be reduced by half. However, if the equity raised by the company
is reinvested (e.g. to acquire another company), the EPS may be impacted
depending upon the outcome of the reinvestment.

Example:

 Shares in Company A are trading at £10 and you own 1,000 of them

 The company has a one-for-ten rights issue, and sets the price of the new
shares at £9.00

 Your entitlement is therefore to 100 new shares at £9.00 each

 If the entitlement to each new share is sellable at 50p, you can sell 93 of
them, raise £46.50 and use that £46.50 to buy 5 of the new shares.

Note that the critical part of this operation is your ability to sell the entitlement
to the rights issue itself. The only reason anyone would want to buy that
entitlement is if the exercise price (£9.00) is below the current market price
(£10.00).

RECENT EXAMPLES OF RIGHT ISSUES

 ➢ Recently, Bank International Indonesia (BII) - a top-layer private
national bank - made its second right issue by offering 1.29 million shares
with a nominal value of Rp 500 per share for Rp 700 per share. Under
this second right issue, a shareholder is allowed to purchase 18 new
shares for every 27 old shares which he/she has. Every 18 new shares are
equipped with Warrant I, which serves as a security that provides the
holder.

➢ Adani Enterprises Ltd, the Rs 26,000-crore flagship company of

Ahmedabad-based Adani group, plans to raise about Rs 5,500 crore
through a rights issue as well as qualified institutional placements (QIP).
The proceeds will go towards repayment of loans and strengthening the
company’s coal mining activity which is critical to its planned power
projects. The company’s board of directors last week approved a rights
issue of 3.11 crore equity

The promoters hold 75% shares in AEL. In a restructuring exercise,

Adanis, the promoters of Mundra Port and Special Economic Zone Ltd
(MPSEZ), have decided to merge their 81% equity holding with AEL. The
rights issue will help AEL turn a near debt-free entity. Analysts say by
strengthening AEL, the promoters are following the Tata Sons model, wherein
the holding company is in sound financial health. The closing price of AEL on
Thursday 2010(April 1) on Bombay Stock Exchange was Rs 474.05

Other examples of companies announcing right issue in recent times are as

below;
Royal Bank of Scotland (RBOS); Announced that it wish to raise £12bn in
the form of right issue at a right price of 200p per share, its current share price
was 246¾p (up 2p), the current share price is still low compared to its price of
659p about 12 months ago.

Halifax Bank of Scotland (HBOS); Announced that it wish to raise £4bn in

the form of right issue at a right price of 275p per share, its current share price
was 430¼p (down 11¼p).

Bradford and Bingley (B&B) Announced that it wishes to raise £300m in the
form of right issue at a right price of 82p per share; its current share price was
103p (up 1½p).

Imperial Tobacco Announced that it wishes to raise £4.9bn in the form of

right issue at a right price of £14.75 per share; its current share price was
£21.29p (up 34p). The right issue was to fund its acquisition of Franco-Spanish
tobacco firm Altadis.
REFERENCES:

www.wikipedia.com

www.warmah.com

www.scribd.com