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Why Do Companies Conduct Rights Issue?
Education | 12 June 2009
Related stocks:
P11
By: Xavier Lim
Articles (51) Profile

First of all, let us establish the definition of rights issue. Rights issue involves shares being offered to existing shareholders at a discount to the current trading price, for the purpose of raising funds for the company. In other words, we can say that rights issue gives shareholders a chance to increase their exposure to the stock at a discounted price.

Rights issue is a way for companies to raise capital. Capital is raised when investors pay for the new shares that are being issued. Companies can use the raised capital to acquire assets, make a take-over, repay debts or save themselves from bankruptcies. Of course, a company can raise capital by other ways, such as borrowing from banks or issuing bonds. However, there can be times where the banks may be reluctant to lend, especially if the company is not doing well. In addition, high interest rate incurred by loans or the issuance of bonds may also force a company to raise capital through rights issue offering.

One must understand that rights issue will cause a company’s net profit to spread over a larger number of shares. In other words, a company’s earnings per share will decrease as earnings allocated to each ordinary share an investor has invested in will be diluted. Rights issue will also cause significant changes to the company’s cash flow. However, one must also understand that capital raised through rights issue can further strengthen the company’s balance sheet and allow it to pursue strategic opportunities in core markets.

Therefore, investors need to make an investment decision as to whether or not they want to take up the rights issue. There are basically 3 options an investor can take.

education-1The 1st option is to take up the rights issue in full. Let us take Pacific Andes (PA) as an example. PA announced efforts to raise capital of $228.6m by offering 1-for-1 rights share at an issue price of $0.15 per rights share, with free detachable warrants on a 1-for-5 basis at an exercise price of $0.23 apiece (additional capital of $70.1m from the exercise of the warrants). In other words, for every 1,000 shares you hold, you will be able to buy another 1,000 shares from PA at a deeply discounted price of $0.15 and get 200 free detachable warrants at an exercise price of $0.23 apiece. Sounds great, but wait! One must remember that the market price of PA’s shares will not be able to stay at a particular future price after the rights issue is completed. To make the calculation simple, let us say that you buy 10,000 shares in PA on the last date before ex-rights, which the share price closes at $0.45. The value of each share will be diluted as a result of the increased number of shares issued. To calculate the theoretical share price, which is the ex-rights share price, you will divide the total price you paid for all your PA’s shares by the total number of shares you own.

education3Theoretically, the value of each of your existing share will decline from $0.45 to $0.30. However, the loss on your existing shareholding is offset by the gain in value of the new rights shares.

Another option you can take is to ignore the rights issue totally. But this option is not wise. Taking the above as example, by choosing to do nothing, you will lose $0.15 per share value as your shareholding will be diluted thanks to the extra shares issued.

The last option is to sell your rights to others. As an investor of PA, you can decide whether to take up the rights issue in full or sell your rights to other investors or to the underwriter. This type of transferable rights is called “renounceable rights”, and after they have been traded, these rights are called “nil-paid rights”. In contrast, “non-renounceable rights” refer to those non-transferable rights.

education41In order to calculate how much you can gain by selling the rights, you need to estimate a value on the nil-paid rights ahead of time. Again, we take PA as an example and assume the share price closes at $0.45 before ex-rights. We will take the value of ex-rights price and subtract the rights issue price.

By selling your rights, you have created a capital gain of $0.15 per rights share.

education-2Pacific Andes Enlarges Working Capital
Pacific Andes (PA) recorded 38% increase in earnings for FY09 due to deferred tax credit of HK$70m compared to a tax charge of HK$26m in FY08. FY09 revenue was up 12% to HK$7,847m. Although FY09 margins were slightly lower than FY08, 4Q09 margins improved across the board from 3Q09.

Yes, it is true that PA’s balance sheet may not look fantastic, but the proposed rights issue of shares with warrants, (please notes that its cash flow has soared more than double in FY09) will definitely boost its working capital. As what PA’s Executive Director and Chairman, Ng Joo Siang has said, “The world’s growing population and increasingly healthy dietary habits have continued to drive global demand for fish, and we have seen demand for our fish products growing in tandem. The outlook for our industry is bright. The additional funding will allow PA to enlarge its working capital and capital base and for general corporate purposes.”

Indeed, international trade in fish and fishery products has been growing strongly, reflecting rising consumption in the European Union, the US and Asia. In addition, growing awareness of the nutritional benefits of eating fish, China’s per capita consumption which is expected to reach 34.3kg by 2030 and the increases in supply to be met through aquaculture, which in turn drives demand for fishmeal further strengthen the prospects of PA.

Based on its net asset value per share of $0.599 coupled with its undemanding FY09 P/E of 4.4 times, PA appears to be lying at attractive valuations.

Armed with an arsenal of investment knowledge, Xavier is the Senior Research Editor at Shares Investment.

Please click here for more information about this author.

Pacific Andes Resources Devt  -- -- --   
Business: Engages in industrial fishing & supply chain mgt of frozen seafood pdts. [FY14 Turnover] Fishery and fish supply (60.6%), frozen fish SCM (39.4%).

Insight: Mar-15, Co's 1Q15 revenue reported a 25.3% drop, w... Read More


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