Taking Stock -Rights issue: is it a dilemma?

THE hyperinflationary environment prevailing in Zimbabwe, coupled with the fall in the value of the local currency has resulted in the shrinkage of balance sheets for most companies.



lvetica, sans-serif”>This effect has also been witnessed in the financial sector where the underwriting capacity of most institutions has been significantly eroded.

Against this mishap is the continued increase in demand for much bigger facilities by both corporate and individual clients in order to cope with the higher capital expenditure and working capital requirements.


This has resulted in some institutions getting into the market to raise their capital base with rights issues being the most preferred method.

Rights issues


Under a rights issue arrangement the company will make an issue of new shares for cash to existing shareholders in proportion to their existing holdings.


Thus a rights issue can therefore also be defined as a way of raising new cash or capital from shareholders – this is an important source of new equity funding for public companies.


Recently we have witnessed Century Holdings Ltd and Zimbabwe Financial Holdings Ltd, both financial institutions, following the path of the rights issue in strengthening their capital base.


In August the shareholders for Century approved a rights issue of 299 829 950 shares.


Finhold on the other hand is seeking to raise over $16 billion from a rights issue of 47 775 102 shares.


According to the company’s directors the move is aimed at further consolidating the company’s position in the financial sector.


Acquisitions have also been on the market as a result of some synergies which exist between some companies or as a move to consolidate the company’s balance sheets.


To finance such transactions, some of the acquiring companies are financing these projects from rights issues.


Of interest is Clan Holdings Ltd’s move to acquire Pioneer Transport (Pvt) Ltd. To finance the deal the shareholders have approved a rights issue of 299 968 200 ordinary shares.


Mashonaland Holdings Ltd is in a deal with Intermarket Holdings, which will see it specialising in property development.


Its shareholders have approved a rights issue of 748 369 359 ordinary shares worth about $26 billion. This will be used to finance the acquisition of properties like Intermarket Life Towers and Charter House among others, on its way to a fully-fledged property development company.


The continued increase in the interest rates over the year has been of major concern.


The current interest rates, which at one point were approaching the 200-percentage point level, have implied a significant increase in cost of borrowing. This means it is now cheaper for companies to raise capital for their projects from shareholders rather than the money market.


Why rights issue?


Raising capital through a rights issue is considered relatively cheap since the costs involved, for example, in preparing a brochure, underwriting commission or press adverts, are largely avoided.


Legally a rights issue must be made before a new issue is made to the public. This is because existing shareholders have the “pre-emption right” (otherwise known as a “right of first refusal”) on the new shares.


By taking these pre-emption rights up, existing shareholders will protect dilution of the shareholding.


Optimal strategy


The shareholder is not obliged to take up his rights issue.

However, taking up of the rights will be to the shareholder’s benefit asillustrated in this article.


Let us consider com-pany XYZ that has 1 000 000 shares currently trading at $10 per share. The firm announces a rights issue of one additional share for every share the shareholders are currently holding at a subscription price of $9,50 a share.


Those who do not wish to exercise their rights may sell them.


What is the value of one right?


After the rights issue there will be 2 000 000 XYZ shares in circulation and an additional capital of $9 500 000 to $10 000 000 already available will have been raised.


The new share price will be $9,75 per share.


Optimal strategy for the investor


For an investor who exercises his rights he will start with one share for $10, takes $9,50 out of his bank account and finishes the day with two shares of $9,75 a share.


Thus his portfolio will be of value of $19,50.


If on the other hand, the investor does not take any action he will be left with one share of value $9,75 plus $9,50 in his account. Thus the total value of his portfolio will be $19,25 implying taking no action will cost the investor $0,25.


For an investor who does not wish to increase his number of shares, he can avoid the loss by taking the rights for $9,50 and then selling the extra share for $9,75.


The investor’s portfolio will also be $19,50.


The investor will not sell the right for less than $0,25 while on the other hand the buyer will be prepared to pay at most $0,25.

Limitations


Under a rights issue arrangement the firm cannot sell large numbers of new shares to institutional investors. On the other hand, it takes long to complete.


They can be mainly effective for listed companies.


In case of private companies, there will be a problem in the case where the shareholders cannot take up the rights. The rights in this case cannot be sold to anybody outside the company.


Rights issues result in an adverse movement of a share’s price if the major shareholders are to dispose off their shares from the rights issue.


Conclusion


With the economic woes bedevilling the country far from over, we are likely to see more companies issuing rights issues to finance their capital project.

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