We often hear about companies raising funds through IPOs and venture capital, but what happens when a company needs more capital for expansion after going public? That’s where options like borrowing and rights issues of shares come into play. Recently, the headlines have been buzzing with news of rights issues from companies like IOC and BPCL.
The central government’s decision to infuse more equity in state-owned companies has set the stage for thrilling developments. The latest buzz in the stock market suggests that Hindustan Petroleum Corporation Ltd (HPCL) and Indian Oil Corporation Ltd (IOCL), following in the footsteps of Bharat Petroleum Corporation Ltd (BPCL), are offering rights issues too.
The central government, in the budget for 2023, pledged ₹35,000 crores in capital support to oil-making PSU companies, including HPCL, BPCL, and IOCL. This capital infusion aims to strengthen the state-owned oil manufacturing companies and boost their operations.
So, let’s take a look at why, how and what it means.
What is a Rights Issue?
A Rights Issue is an offer for existing shareholders to increase their stake in a company by purchasing additional shares at a discounted price. This exclusive opportunity allows shareholders to exercise their right to buy more shares, contributing to the company’s capital-raising efforts.
It’s important to note that participating in a rights issue is a choice, not an obligation. Shareholders have the right to decide whether they want to increase their shareholding or not. Rights issues can be both enticing and concerning for investors.
Rights Issue eligibility:
To participate in a rights issue, shareholders must meet specific eligibility criteria:
- Shares must be owned before the record date.
- Shares purchased on or after the ex-date are not eligible.
Let’s get a clear picture with an example:
Imagine a company announcing July 6, 2023, as the record date for its rights issue.
To be considered an existing shareholder, you must own the company’s shares in your Demat account on or before July 6.
If you buy the shares on July 5, even though it’s before the record date, you won’t be eligible as the credit of shares in your Demat account will occur on July 8. Remember, shares become ex-rights from July 6.
Current or ongoing Rights Issues 2023
To give you a taste of how common share rights issues are, here’s a handy table showcasing ongoing and upcoming rights issues. Keep an eye on these opportunities and make a smart move with your investments.
|Issue price (Per
|CMP of Share
|Rights Issue Ratio
|G G Engineering Limited
|Eiko Lifesciences Limited
|Alan Scott IndustriesLimited
|North Eastern Carrying Corporation Limited
|Cressanda Solutions Limited
Why do companies consider a Rights Issue of shares?
What motivates them to raise capital through this avenue? Let’s unravel the mystery!
Reduce debt-equity ratio:
One common reason a company prefers a rights issue is to bring down its debt-equity ratio. To become more agile and attractive to investors.
Capital for companies:
When companies find themselves in dire need of capital but want to avoid increasing their debt burden, a rights issue comes to the rescue. Financial lifeline without the added loans.
Fuel for expansion and corporate objectives:
Companies may also use rights issues to fuel their growth ambitions, such as expanding their operations, making acquisitions, or pursuing other corporate objectives. Let’s come back to IOC and BPCL.
IOCL and BPCL are looking to raise capital through rights issues of equity shares to fund their respective capital expenditure plans. IOCL has set a capital expenditure target of Rs 30,395 crore for FY24, supporting its growth objectives and investment projects.
BPCL aims to raise up to Rs 18,000 crore to achieve energy transition, net zero, and energy security objectives. The Indian government is expected to invest Rs 9,000 crore in BPCL during the rights issue process.
Both companies’ rights issues are part of the government’s plan to infuse capital in oil marketing companies to support energy transition and net-zero objectives (balance between the amount of greenhouse gases emitted and the amount removed from the atmosphere).
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Rights Issue Options
When it comes to a rights issue, you hold the power to make decisions. Look at the options and choose the path that suits you best:
- Exercise the right in full and apply for eligible rights shares.
- Exercise the right in full and apply for eligible rights shares plus additional rights shares.
- Ignore the rights entitlement fully and let the rights lapse. No action is required.
- Exercise partial rights and let the remaining rights lapse.
The impact of Rights Issue on share prices
When a company offers a rights issue, the number of shares in the market increases, leading to share price dilution. Here is a formula to estimate the post-rights issue share price.
The Theoretical Ex-Rights Price (TERP)
TERP = (Rights Share * Offer Price + Existing Shares * Market Price) / Total Number of Shares
Let’s break it down with an example. ABC Company announces a rights issue in the ratio of 1:5, which means one share for every five held. The discounted offer price is Rs. 250, and the current market price is Rs. 300. Applying the TERP formula, we estimate a rough share price post the rights issue:
TERP = (1 * 250 + 5 * 300) / 6 = Rs. 291.67
So, we can expect the security to trade around Rs. 291.67 ex-rights. Remember, this is just an estimation, and market sentiments may sway the actual share price.
Disadvantages of a Rights Issue
While rights issues have their merits, they also come with a few drawbacks. Let’s shine a light on these potential challenges, especially when a company is in financial trouble:
- Warning Signals: When a company resorts to a rights issue, it could be a red flag for investors, indicating financial difficulties.
- Reputation Blues: A company’s reputation can take a hit when it’s short for cash, causing a decline in share price.
- Diluted Profits: More shares in circulation mean profits get spread across a larger pool, impacting earnings per share (EPS).
- Dilution Dilemma: When rights issue shares hit the open market, their value may dilute due to increased supply.
- Shareholder Sell-Off: Some shareholders might perceive a rights issue as a sign of struggle and decide to sell, putting downward pressure on the share price.
- Slow-Growth : In the case of slow-growing companies, a rights issue may find fewer takers.
The path Forward
Before diving into a rights issue, conduct thorough research to understand the company’s reasons for choosing this funding method. Remember:
A rights issue introduces additional shares and dilutes the stock’s value. If the capital raised is used for business expansion, it can lead to company growth and potential returns for investors. Stay alert for reasons behind initiating a rights issue. You might strike gold if a large-cap company issues its rights shares.