Rights offers: What you need to knowRights offers: What you need to know

How rights offers work

In a rights offer, a company gives existing shareholders the opportunity to buy more shares in the company—usually at a discounted price, and in proportion to the amount of shares they already own (called pro rata). You’ll find details about the rights offer in the announcement that the company makes to the stock exchange.

The entitlement ratio sets out the number of shares each shareholder can buy through the rights offer. For example, an entitlement ratio of ‘1 for 10’ means you have the right (are entitled to) buy 1 share for every 10 shares you already own at the offer price. If you own 100 shares in the company, you have the right to buy up to 10 shares at the offer price. This is the main difference between rights offers and share purchase plans. 

Other terms you might see as part of a rights offer include:

• Offer price: the price you’ll pay for every new share you buy through the rights offer. This is set by the company, and is usually at a discount to the current market price of the company’s shares. 

• Offer size: how much money the company is trying to raise through the rights offer, and the number of new shares this equals.

• Renounceable and non-renounceable: if a rights offer is ‘renounceable’, you can sell your rights to someone else who can use these rights to buy the shares that you’re entitled to. A ‘non-renounceable’ rights offer means you can’t do this. 

• Closing date: the deadline for participating in the rights offer.

• Record date: the date on which you had to have owned shares in the company to be able to participate in the rights offer. Generally to be eligible, you need to purchase shares two business days before the record date to allow for T+2 settlement times.

Some ways rights offers may impact investors

Each rights offer will have its own impacts on the company and potentially the share price.

Dilution

When a company issues new shares and raises capital (cash), it can cause dilution to occur. Dilution is when the percentage of the company owned by each existing shareholder decreases. By issuing new shares, the percentage ownership of the company represented by each share drops. It’s like slicing a pie into smaller and smaller pieces—there are more pieces, but each one is smaller. 

Rights offers can give shareholders a way to avoid dilution when a company chooses to raise capital—but only for the shareholders who participate and buy their full allocation of shares. 

If you fully participate in the rights offer (going back to our example, buy 10 shares for the 100 you already own) and the company successfully raises the amount of money it’s aiming for, you’ll own the same percentage of the company after the capital raise as you did beforehand.

If you don’t participate in the rights offer, or you don’t buy your full allocation of shares, then you’ll likely experience dilution. 

Movement in share price

As we mentioned earlier, the offer price is usually set at a discount to the current market price. This may potentially cause a decline in the company’s share price once the rights offer has taken place. For example:

• Let’s say that a company has 1 million shares at a market price of $2 per share (making the company’s market capitalisation $2 million).

• Then, the company does a ‘1 for 2’ rights offer at a discounted price of $1 per share. If all of the company’s shareholders participate in the offer, 500,000 new shares will be issued to the shareholders and the company would raise $500,000. 

• Theoretically, the company’s market capitalisation (total value) would now be $2.5 million (the initial $2 million, plus the $500,000 raised from the rights offer).

• The company would also now have 1.5 million shares outstanding (the initial 1 million shares, plus 500,000 from the rights offer).

• If you divide $2.5 million (value of the company) by 1.5 million (shares outstanding), that works out to be $1.67 per share—lower than the original market price!

This price is called the theoretical ex-rights price (or TERP). It represents what a company’s share price would theoretically be after the rights offer. Sometimes a company will calculate this for you, and other times you might have to calculate it yourself. Generally, this calculation means that the greater the discount and number of new shares that are issued, the lower the TERP.

If you participate in the rights offer and the offer price is at a discount, buying the shares at this lower price means you might be able to offset some of the potential share price impact that the rights offer could have (going back to our TERP calculation).

If you don’t participate in the rights offer and the offer price is at a discount, your investment might be at risk to a potential decline in the share price. 

But remember, the TERP is theoretical only—nobody has a crystal ball, and you never know for sure what the actual share price will do.

Things to consider

You should read the offer document from the company. Doing due diligence for every investment decision you make is important, and rights offers are no exception. Here are some questions to ask yourself:

What’s the offer price?

What’s the offer price? How does this compare to what you think the company is worth? You may also want to consider the size of any discount on the offer price to the current share price, the TERP, and how these things could potentially impact your investment portfolio.

Why is the company raising money?

Companies raise money for a number of reasons, and you may want to think about what that means for the company and its future. Does the company need money so it can grow, pay off existing debt, or is the company having difficulties?

What would not participating look like?

If you don’t participate, your ownership percentage in the company may be diluted and your shares may lose some value—but you also won’t be investing more money into the company. It’s worth considering if there’s any potential to receive some value from your rights if you don’t participate, such as being able to sell them (if the offer is renounceable).

What does the rest of your portfolio look like?

Taking part in a rights offer means that you’re buying more shares in a company you’re already invested in. Think about how many shares you might want to buy, and what this means for the makeup and diversification of your overall portfolio. It’ll also require you to front up with more money to purchase the shares, so consider whether this is the right option for you.

Your options

If you receive rights to take part in an offer on Sharesies, you have a few options:

• Exercise the rights, or a portion of the rights, and pay the offer price per share to get your allocation of shares in the rights offer. You’ll need the money to participate, but it means you might avoid any dilution and help offset the potential decline in the share price resulting from the rights offer.

• Don’t exercise your rights. You don’t have to participate in the offer if you don’t want to, but your existing shares will get diluted, and may lose value. If the rights offer is renounceable and you choose to not participate, you may be able to sell these rights and receive some value for any rights you sell. If the offer is non-renounceable and you don’t exercise your rights, you may not receive any benefits.

• A combination of the above. It’s not all-or-nothing. You can choose to exercise some of your rights (but not all of them), and then try to sell (if the offer is renounceable), or not take up the rest.

If you don’t participate in the rights offer, there may be an opportunity to get some value from your rights. If the offer is renounceable, this might be done by selling the rights on a market (similar to trading shares) or through a shortfall bookbuild (or shortfall offer).

A shortfall is when a company tries to sell any new shares that are leftover (due to some shareholders not exercising their rights) to other investors. If there are rights that haven't been taken up, it means that the company might not have raised the full amount of money that it was trying to. A shortfall bookbuild tries to raise this remaining amount. 

If you don’t exercise your rights and the shares they entitled you to buy get sold through the shortfall bookbuild, you may get to receive some value for them. In most cases, this value is calculated as the difference between the price the new shares are sold for through the shortfall bookbuild and the offer price of the rights offer—if there is one.

With both selling the rights on a market and a shortfall bookbuild, there’s no guarantee that you’ll get any value for your unexercised rights.

If you participated in the rights offer and are interested in buying more shares in the company, you might get the chance to purchase shares through a shortfall or trade them on a market. You may be able to apply for this through Sharesies—but there’s no guarantee you’ll be able to get these shares if there’s lots of demand!

Wrapping up

Whether participating in a rights offer is right for you depends on your goals, risk tolerance, and portfolio’s diversification. So it’s important to read the offer document and do your research. If you’re a Sharesies investor and a company you’ve invested in does a rights offer that we can facilitate, we’ll contact you to let you know what your options are and how to take action.