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Rights issue decoded: Ignoring this isn't in your interest

Equity rights issues that have hit the Dalal Street so far this year includes telecom giant Vodafone Idea's Rs 25,000 crore issue, which is the largest-ever by any company in the country. It opened for subscription earlier this week and will close on April 24. Market rival Bharti Airtel's similar size issue is expected to come out soon.

Aprajita Sharma  New Delhi     Last Updated: April 12, 2019  | 15:42 IST
Rights issue decoded: Ignoring this isn't in your interest
5 rights issues have hit the Dalal street so far, this year

Rights issues have once again become the flavour of the stock market and at least five of them have hit the Dalal Street so far this year. This includes telecom giant Vodafone Idea's Rs 25,000 crore issue, which is the largest-ever by any company in the country. It opened for subscription earlier this week and would close on April 24. Market rival Bharti Airtel's similar size issue is expected to come out soon. Before you choose to participate or ignore this corporate action, let's understand what rights issues are and how they impact the shareholder value:

What is the rights issue?

The companies in dire need of capital come up with the rights issue (either to pay the debt or expand the business), wherein they offer extra shares to existing investors in the proportion of their current shareholding at a discounted market price. In the case of Vodafone, shareholders are getting 87 rights shares for every 38 shares they hold now. The company offered a steep discount of 60 per cent on its rights issue against the stock price when it announced it last month.

Although a rights issue gives you a right not an obligation to buy extra shares, investors should not ignore this corporate action, as post-issue, the value of shares that you hold are diluted, due to new shares being issued. In the case of Vodafone, the rights issue will amount to 70 per cent post-issue equity dilution. If you don't participate, your equity will be diluted even more. While return on equity (RoE), earnings per share (EPS) and dividends reduce for each shareholder -- since there are now more shares for the same earnings -- the reduction will be more for those who let their rights lapse.

Don't ignore; sell your right

If uninterested, existing investors can sell their rights to other investors. This will be like selling a call option that is in the money (ITM).

Deepak Jasani, Senior Vice-President, Head-Retail Research, HDFC Securities, believes Rs 2.5-3 is the fair price to sell the rights going by the difference between current market price (Rs 16) and the rights share price (Rs 12.50) and factoring in the risks involved.

Why rights?

The companies that require additional capital and are already in huge debt prefer this mode of raising funds. Vodafone and Bharti Airtel require capital to reduce debt and invest in a broader 4G network.

"Telecom companies because of their underperformance have been out of flavour for both retail and institutions. As the debt levels of these companies are already high, so they have taken the financial decision to raise funds through equity. A rights issue suggests that promoters are showing comfort in business and this is reflected through their higher participation in the issue," says Vineeta Sharma, Head of Research, Narnolia Financial advisor.

Besides, raising funds via rights issue improves the company's debt/equity ratio, making it more comfortable in raising debt in the future.

How to judge a rights issue?

Investors should analyse the discount on offer, the objectives behind raising money and amount of equity dilution versus what the future holds for the company. You shouldn't buy rights just because they are cheaper than the market price. You should analyse if funds would be invested in a rightful manner. In Vodafone's case, brokerage Motilal Oswal (MOSL) believes, the impact of the steep equity dilution could be offset in the long term by the huge growth opportunity if the company manages the current liquidity situation well.

"Our positive stance is mainly premised on the healthy promoter backing and the strong operating leverage opportunity from any ARPU increase," MOSL said in a report.

Should retail and institutional investors treat rights issues differently?

No, says Ravi Menon of Elara Capital. "Both retail and institutional investors regard rights issues the same way- what is the use of proceeds and whether it will improve the firm's profitability and revenue growth."

Should you subscribe?

As the earning trajectory is volatile for both companies, say street experts, the near-term stock price gain may not happen; however, promoters' participation instils some confidence for the way forward.

"Vodafone and Airtel rights issues are attractively priced for anybody who wants some exposure in the mobile telecom business. However, when you will make money is a different matter because the company will need more funds, thereafter. It will be difficult for telcos to record growth unless mobile and data tariffs rise. The sooner it happens, the better," says Jasani.

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