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Rights issue of shares
What is a rights issue of shares?
A rights issue is when a company issues its existing shareholders a right to buy additional shares in the company. The company will offer the shareholder a specific number of shares at a specific price. The company will also set a time limit for the shareholder to buy the shares. The shares are often offered at a discounted price to encourage existing shareholders to take the company up on their offer.
If a shareholder does not take the company up on their rights issue then they have the option to sell their rights on the stock market just as they would sell ordinary shares, however their shareholding in the company will weaken.
Reasons for a rights issue of shares
A company will offer more shares to its shareholders to raise extra money for the company. Companies with a poor cash flow will often use a rights issue to increase cash flow and pay off existing debts. Rights issues however are sometimes issued by companies with healthy balance sheets in order to fund research and development projects or to purchase new companies.
Discounted shares issued by a company can be tempting but it is important to find out first the reason for the rights issue of shares. A company, for example, may be using the rights issue as a quick cash fix to pay off debts masking the real reason for the company’s cash flow failing such as bad leadership. Caution is advised when offered with a rights issue.
Example of a rights issue of shares
- Company ‘ABC Mining’ has 10 million shares at a share price of $8 (market capitalization $80million)
- Joe Bloggs owns 1,000 shares worth $8,000
- ABC Mining needs to raise $30 million to research new mining locations.
- ABC Mining issues 5 million new shares @ $6 each (to raise $30 million, a 25% discounted price)
- This is classed a a 2 to 1 rights issue (10 million old shares : 5 million new shares)
- Which means every 2 shares you own ABC mining will issue another 1 share.
- This means Joe Bloggs is being issued with the right to buy a further 500 shares at $6 ($3,000)
Joe Bloggs can either;
- Buy the further 500 shares for $3,000.
- Ignore ABC Mining’s rights issue. This will result in Joe Bloggs share holding will be diluted along with the value of his current share holding. This option is not usually advised.
- Sell his rights on the stock market and make a profit (providing the rights are renounceable, if a company issues non-renounceable rights then they can not be traded
As you can imagine the stock price is likely to change after a rights issue of shares. This is called the ex-rights share price. It is possible to estimate the ex rights share price by;
- Taking Joe Bloggs original shareholding of 1000 shares @ $8.00 worth $8,000
- Taking Joe Bloggs new 500 shares @ $6.00 worth $3,000
- Adding the total values together $8,000 + $3,000 = $11,000
- Dividing the total value ($11,000) by the total number of shares (1500) = $7.33 per share.
However the ex-rights price can be influenced by many other factors such as the reason for the rights issue, the general direction of the stock market etc.
Real example of a rights issue of shares
Read more about Nationl Grid’s rights issue here.
Find out more about how to make money from a falling share price – shorting stock.
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Stock market basics
Stock charts explained
Stock dividends explained
Stock Split Explained
Why do shares move up and down?
How do I read a stock quote?
Understanding company financial statements
Rights issue of shares
The process of buying shares
Why buy shares
Age limit for trading shares
Tax rules on shares
Styles of trading
Buying (going long)
Shorting stock (going short)
Stop losses explained
Stock market trading guide
Stock market games
Advanced stock market trading