We’re seeing another spate of rights issues on the JSE, so we thought we’d look into their workings as they are an important part of the market and investors need to understand the implications and responsibilities of owning these instruments.
A rights issue is a process whereby a company issues new shares for cash as a fund-raising exercise. The company has to offer these new shares to existing shareholders but they can effectively decline and we will delve into this process.
But first, why a rights issue? A loan is the preferable method of raising cash as it gets paid back and has no long-term impact on the company. A rights issue, on the other hand, results in new shares being issued and these new shares have a lifelong right on profits, effectively diluting the existing shares.
For e xample, i f a company has 1 000 shares in issue and profits of R100, meaning profit per share is 10c. The company issues a further 1 000 new shares and suddenly the profit per share drops to 5c – this is dilution. The profit has not increased but the number of shares entitled to a slice of the profit has increased. So a company only goes the rights issue route as a last resort. The Super Group double rights issue worked very well and the share price has moved strongly since while Curro rights issues have had no impact on the share price rise. Blue Financial, on the other hand, survived but the share price is back where it was when the issue happened, although it did rally strongly in the year following the rights issue. So while it does help a company survive, it may not help the share price.
The t wo most recent rights issue announcements have come from Gijima and RBA Holdings, with the former offering 3bn new shares when it currently has just under 1bn in issue. This is massive dilution and indicates that the company is struggling.
The second part of the rights issue is the take-up price and the trading of the nil paid letters (NPLs) on the JSE. The new shares will be issued at a take-up price, essentially the price at which investors will buy the new shares. This price is nearly always at a discount of sorts to the existing share price. Gijima’s take-up price is 5c and the share was trading at 15c at the time of announcement while the RBA take-up is 8c and the share had been trading at around 11c.
Existing shareholders will be given NPLs in the specified ratio; with Gijima it is 309 for every 100 share currently held and these NPLs will trade as GIJN (the N denoting NPL). GIJN will trade freely on the JSE and one can either exercise them (and buy one new GIJ share at 5c for every GIJN owned) or they can be sold on the open market. The NPL price would be the GIJ price less the take-up price, so with GIJ at 12c the GIJN has a value of 7c. One could buy these NPLs and exercise them as a way to get GIJ shares albeit this is unlikely to be any cheaper than just buying GIJ.
Very importantly, these NPLs have an expiry date that would have been published with the SENS announcing the confirmed details of the issue. A holder of the NPL has to either sell the NPL or inform their broker they wish to take up the rights on or before that date otherwise the NPL expires with zero value.
The main issue to watch out for is the level of dilution, and with Gijima it is massive. Also have a look at which of the major shareholders are supporting the rights issue; this always gives an indication of who is putting their money where their mouth is. An existing shareholder has to decide if they will follow their rights and take up the new shares or if they would rather sell the NPLs, effectively diluting their current holding. Either way you must either inform your broker or sell the NPLs before the expiry date.
Simon Brown is a Finweek contributor and heads justonelap.com, a free resource of financial information and investment education.