Reliance, after a gap of 29 years, has announced a Rights Issue on 30th April, 2020. But most of us do not know what a rights issue is and what are its implications for the retail investor.
Before going into the details of rights issue, first let’s understand that a right issue is done to raise additional capital. What are the ways in which a company can raise capital from the public?
- Initial Public Offer (IPO)
- Rights Issue
- Follow on Public Offer (FPO)
IPO is issued by a company when it is getting listed in the stock market for the first time. So the Rights issue and the FPO are used by companies which are already listed in the market to raise additional capital from the public. In a rights issue, a listed company usually taps on to the existing shareholders to raise the additional capital and usually a preferred method than an FPO wherein the listed company needs to get capital from the general public.
What is a “rights issue”?
A rights offering (rights issue) is a group of rights offered to existing shareholders to purchase additional stock shares, in proportion to their existing holdings.
Definition as per Investopedia
So, the basic necessary condition that you have to fulfil if you are to avail the rights issue by a listed company is that you should be a shareholder of the company which is issuing the rights issue. The company may announce a specific ratio as per which the existing shareholders can buy the additional shares. For example, a 1:4 rights issue means that the existing shareholders can buy one additional share for every 4 shares that they hold. The most important aspect of a right issue is that the additional shares that the existing shareholders get are usually issued at a discount compared to its current market price. For example Reliance has announced a rights issue in the ratio of 1:15 at a discount of 14% on the market price as on April 30th, 2020. The advantage for existing shareholders availing rights issue is that they could grab some additional shares at a discounted price.
The advantages for the company going for a rights issue is the simplicity it offers to raise funds from existing shareholders. Instead of going all out to acquire funds, the company can turn to rely on their own patrons. Acompany can use funds raised from such a rights issue to reduce their debt, capital expansion, buy another company etc.
The major disadvantage with right issue for a shareholder is dilution of their shareholding. What is dilution here? For example imagine that you are a shareholder in a company that has 100 shareholders each having 10% share in the company. Suppose the company issues 100 additional shares. However you chose not to get any additional share. Now what happens to your shareholding percentage in the company? Since now there are 200 shares and you just own 10 shares out of them, it will be just 5% compared to 10% shareholding that you enjoyed before the issue of additional shares.
Reliance Rights Issue
Now we will come to the rights issue announced by Reliance Industries Limited on April 30, 2020. As said earlier, Reliance has offered 1:15 additional shares at 14% discount to market price to raise additional capital of Rs. 53,125 crore. This is by far India’s biggest rights issue offer. Why is Reliance doing this? Because they have a net debt of around Rs. 1,53,132 crore. The recent Reliance Jio – Facebook deal has brought in Rs. 43,574 crore of funds for the company. Reliance is targeting to be a debt free company by 2021. Hence the company is looking at all avenues to reduce their debt levels. The Facebook deal and this rights issue could clear nearly Rs. 1 lakh crore of debt for the company which will go a long way in achieving the debt-free goal set forth by the company.
So if you are an existing investor in Reliance Industries Ltd., What should you do?
You have two options: either to go and subscribe for the rights issue or to ignore it completely. In case if you get the additional shares, you have the option to sell them at market price and make some profit. There are lots of ifs and buts, like what will happen if the actual market price comes down to the issue price even before the closure of the rights issue? In such a scenario, it is obviously better to buy a share from the open market instead of the rights issue. As such a 14% discount and a 1:15 additional shares rights issue may not excite retail investors like you and me but the High Networth Individuals (HNIs) and other institutional investors would most likely be willing to pitch in.