Rights Offering

A Rights Offering (also known as a 'Rights Issue') is an invitation from a company to its existing shareholders to purchase additional shares of the company's stock, typically at a discounted price relative to the current market price. Think of it as a special, members-only sale. The company issues “rights” to each shareholder, with the number of rights received being proportional to the number of shares they already own. For example, a shareholder might receive one right for every ten shares they hold. These rights give the owner the option—but not the obligation—to buy new shares at a specified price (the 'subscription price') within a short timeframe, usually a few weeks. The primary goal for the company is to raise fresh capital without the hefty fees of a traditional secondary offering that involves underwriting banks. For shareholders, it’s a way to increase their stake in the company and, crucially, to protect their ownership percentage from the dilution that occurs when a company issues new stock.

Imagine a company as a pizza cut into 100 slices, and you own 10 of them (10% of the company). The company decides it needs more money to build a new, super-efficient pizza oven. To raise this cash, it decides to issue 20 new slices. A rights offering gives you the first crack at buying some of these new slices before they're offered to anyone else. The company will issue you “rights” based on your current holdings. For instance, you might need five rights to purchase one new share at the discounted subscription price. This mechanism is designed to be fair to existing owners. If you participate, you can maintain your 10% ownership stake. If you don't, and others do, the pizza will now have 120 slices, but you'll still only have 10. Your ownership has been diluted from 10% down to 8.3% (10 / 120). The value of your rights is meant to compensate you for this potential dilution. Companies turn to rights offerings for several reasons:

• Capital for Growth: To fund expansion, new projects, or acquisitions.
• Debt Reduction: To pay down loans and strengthen the balance sheet.
• Financial Distress: Sometimes, a struggling company will use a rights offering as a last-ditch effort to raise cash.

When you receive rights in your brokerage account, you have a decision to make. Doing nothing is almost always the wrong answer, as the rights themselves have value. Letting them expire is like throwing away a winning lottery ticket, even if it's only for a small prize.

You generally have three options, and you must act before the expiration date:

1. 1. Exercise the Rights: You use the rights to buy the new shares at the discounted price. This makes sense if you believe in the company's long-term prospects and want to increase (or at least maintain) your ownership stake. You're effectively doubling down on your investment.
2. 2. Sell the Rights: Most rights are transferable and can be sold on the open market just like a stock. If you don't want to buy more shares, or perhaps you don't have the cash, you can sell your rights to another investor. The price they'll pay reflects the value of the discount being offered. This is how you cash in on the value of the rights without putting up more capital.
3. 3. Let the Rights Expire: This means you do nothing. The rights disappear from your account, worthless. Your ownership percentage in the company is diluted, and you receive no compensation for it. This is almost always a poor financial decision. Some offerings may include an oversubscription privilege, allowing you to buy even more shares than you were initially allotted if other shareholders don't exercise their rights.

For a value investor, a rights offering isn't an automatic “buy” just because of the discount. The discount itself isn't free money; it's a mathematical adjustment to prevent your stake from being watered down. The real question is why the company needs the money and whether it remains a good investment. A true value investor must dig deeper:

• Purpose of the Capital: Is the money being raised to fund a brilliant, high-return project that will boost the company's intrinsic value? Or is it to plug a hole in a sinking ship, paying off crippling debt from past mistakes? The former is a green flag; the latter is a serious red one.
• The Price is Right?: Forget the discount for a moment. After the offering, is the company's stock still trading below your estimate of its long-term value? Does it still have a sufficient margin of safety? A 20% discount on a stock that is 50% overvalued is still a bad deal.
• Management's Track Record: Do you trust the management team to use this new capital wisely? Their past performance with capital allocation is your best guide to their future success.

A rights offering from a well-managed company with exciting growth prospects can be a fantastic opportunity. But one from a struggling company could be a signal to reconsider your entire investment.

People often confuse rights with warrants, but they are quite different animals.

• Lifespan: Rights are short-term, expiring in a matter of weeks. Warrants are long-term, often lasting for several years.
• Audience: Rights are issued exclusively to existing shareholders. Warrants are often sold to the public or attached to other securities (like bonds) as a “sweetener” to make them more attractive.
• Price: The subscription price for a rights offering is set below the current market price to create an immediate incentive. The exercise price for a warrant is often set above the current market price, representing a bet that the stock will rise significantly over the long term.