Indians love discounts. Imagine that you go out in the market for shopping and see SALE signs everywhere; how will you feel? What if there is a SALE in the Stock Market, and instead of merchandise you see discounts being offered on stocks, will you rush to buy? Make sure you read this article before you do so.
Do you own at least 15 shares of Reliance Industries Limited? If yes, you must have received a communication from the company about the “SALE” on their shares. In market terms, it’s called a “Rights Issue”.
What is a Rights Issue?
In the simplest language, a Rights Issue is an invitation to the existing shareholders of a company to purchase additional new shares of the company at a discounted price.
So, if you are a shareholder of a company and if it decides to come up with a Rights Issue, you will be among the first few to get the rights to buy shares of that company on a future date decided by them.
However, not all shareholders will get the rights to buy shares at a discount. Company announces a date called a “Record Date” and if you were holding company shares on the record date, then only you will be eligible for the Rights Issue.
How is Rights Issue Different from an IPO?
Clearly, an IPO is the first time when a private company makes its shares available to general public. There is no particular restriction as who can buy those shares.
In case of a Rights Issue, a publicly listed company issues more shares when they need more capital for their business from the market, and this time only existing shareholders get a chance to buy those shares.
What Can You Do with the Rights Issue?
1. Exercise the Rights
Yes, grab the opportunity. Let’s assume that you are holding 100 shares of a company (let’s say TCS) and it declares 1:2 rights issue. That means for every 2 shares of TCS you own, you can buy 1 additional share at a discounted price compared to the current market price of TCS. So, in this case you can apply to buy 50 more shares at a bargain.
Let’s see an example. If I have 100 TCS shares whose current market value is 1944 (this is the actual closing price of TCS for today as I write this article). TCS announces 1:1 Rights Issue at 20% discount. That means I become eligible to buy additional 100 shares of TCS at around ₹ 1555 per share.
If I decide to exercise my rights and buy 100 shares, my total investment value becomes,
(100 x 1944) + (100 x 1555) = 349900
Now I have 200 TCS shares with me. That means, my effective price per share becomes,
349900 / 200 = 1749.5
See, my effective share price came down to 1749.5 per share, where as current TCS price in open market is 1944. If I decide to sell these shares in open market, I can book a good amount of profit.
2. Renounce the Rights
Suppose you get a discount coupon of McDonald’s, but you are not in a mood to eat burger and fries. What will you do? You may give it to your friend who might be interested. Similarly, if you are not interested in buying those company shares, you may give your rights to someone else for free, or sell it for a price.
Now, why will someone else buy the rights? Simple. In our example, if they are not shareholders of TCS already, they are not eligible to buy TCS shares at a discount, and they are missing out this opportunity. By buying rights from you, they are actually trying to grab this opportunity. Once they buy rights from you, they become eligible for purchasing shares.
Let’s take our TCS example again. I have 100 TCS shares whose current market value is 1944. TCS announces 1:1 Rights Issue at 20% discount. But this time I am not interested in buying additional TCS shares for some reason. You are very much interested in this deal but since you don’t have any TCS shares with you, you cannot get the discount. Now, if I decide to sell my rights to you for ₹200 per share, wouldn’t you be interested? Let’s see what’s the benefit for both of us in this deal.
If I sell my rights, I cannot buy additional TCS shares. So, my shares count is still 100. Now, since I sold you my rights for ₹200 per share, I earned additional ₹20000 and my effective share price of TCS became,
(1944 x 100 – 20000) / 100 = 1744
For you, since you paid me ₹200 per share and bought 100 TCS shares at ₹1555 (20% discount), your effective share price became,
(1555 x 100 + 20000) / 100 = 1755
See, it’s a Win-Win. Such transferable rights are called “Renounceable Rights”.
3. Ignore the Rights
Not all the Rights Issues are renounceable. If a company decides to issue non-renounceable rights, and you don’t want to exercise those, you can just do one thing – Don’t Do Anything. In such cases, your rights are wasted.
But by not doing anything, don’t assume that nothing is going to happen to your investment. When more shares of a company are available in the market for trading, it creates more supply, and as per the rule of demand & supply, when supply increases – price decreases. Ideally there should be more demand also because of discounted price, but since everyone is not eligible to buy, the demand cannot surpass the supply and hence the share price may fall, creating a dent in your investment.
So, what are you going to do if you get rights to buy shares at a discounted price? Please let me know in the comments section below. I read every comment.
Author: Netrey Powdwal (Co-Founder & Partner, ExpressWealth®)