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 justonelap.com, a free resource of financial information and investment education.