Last re­sort

Finweek English Edition - - INVESTMENT -

The Lon­min rights is­sue has got ev­ery­body talk­ing, not only for the size and level of di­lu­tion but also around the process of a rights is­sue. Com­pa­nies of­ten need more money, and the rea­sons be­hind Lon­min’s need are well known. Ide­ally a com­pany would bor­row money from a bank, pay it back with in­ter­est and end up with a larger more prof­itable com­pany. But bank loans are not al­ways prac­ti­cal or de­sir­able. In the case of Lon­min, a part of the prob­lem is that the com­pany has too much debt on its bal­ance sheet and is rais­ing money to pay down that debt.

So a new loan was not a so­lu­tion and hence it went to the mar­ket for money us­ing a rights is­sue.

The re­sult of a rights is­sue means the money does not have to be re­paid but it does make all the shares in the com­pany less valu­able as there are more shares in is­sue, ba­si­cally they are sell­ing a large part of the com­pany at dis­count to cur­rent val­ues – this is di­lu­tion and if you wanted to avoid be­ing di­luted you need to pur­chase new shares at cost.

So share­hold­ers ei­ther spend money buy­ing new Lon­min shares or have their hold­ings di­luted.

The process is that they is­sue new Lon­min shares and sell them (at a dis­count) to ex­ist­ing share­hold­ers. An im­por­tant part of a rights is­sue is that while new shares are be­ing sold to the pub­lic, they must first be of­fered to ex­ist­ing share­hold­ers in equal por­tion to their ex­ist­ing hold­ings in the com­pany.

In or­der for Lon­min to sell th­ese new shares, the com­pany is­sued nil-paid let­ters (NPLs) to ex­ist­ing share­hold­ers at a rate of 1.8 NPLs per cur­rent Lon­min share held.

Th­ese NPLs give hold­ers the right to buy new Lon­min shares at R19.4872 (takeup price) and are traded on the JSE ex­actly like any other share.

As a holder of Lon­min NPLs (code is LONN) one must ei­ther take up the right to buy the new Lon­min shares or sell them on the mar­ket. If you want to take up part or all of your al­lot­ment of LONN you must in­form your bro­ker and have the cash avail­able in or­der to pay the takeup price.

If you want more LONN (in or­der to buy more LON shares at the takeup price) you sim­ple buy more on the mar­ket.

If you do not wish to take up your right to new shares, you must sell the NPLs on the mar­ket. Their value will be the Lon­min share price less the takeup price and they will f luc­tu­ate in line with the Lon­min share price. Which­ever op­tion you de­cide on, it has to be done be­fore the ex­piry date, in this case 03 De­cem­ber 2012.

The ques­tion you are left with is, are rights is­sues a good thing for a com­pany?

The short an­swer is no. Ide­ally, you bor­row money that you pay back and there is no long-term li­a­bil­ity to the com­pany. A rights is­sue means more shares and th­ese shares are a per­ma­nent li­a­bil­ity to the com­pany paying div­i­dends and earn­ing prof­its.

In time, a com­pany can buy back shares on the open mar­ket re­duc­ing the li­a­bil­ity, but closer to the truth is that a com­pany does a rights is­sue as a last re­sort. It is far from ideal, but if it en­sures the sur­vival of the com­pany, it’s a price worth paying.

Simon Brown is a Fin­week con­trib­u­tor and heads ju­s­, a free re­source of fi­nan­cial in­for­ma­tion and in­vest­ment ed­u­ca­tion.

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