In my earlier articles on Bonus issue, we have place a lot of emphasis on understanding what is bonus issue and its purpose, mechanism and accounting treatment of bonus issue. I have also attached some local scenes on corporate round-up on bonus issue to reinforce a greater and practical understanding of bonus issue.

Next, we look at right issues.

Firstly, what is Rights Issue?

Rights issue

• is an offer by a company to its existing shareholders the right to subscribe for a specific number of additional shares in the company for cash
• the new shares are allocated in proportion to the shares held by the existing members;
• the new shares are offer normally at a lower price than the prevailing market price and
• the shareholders are given a period within which they have to exercise their rights.

Interestingly, the basic question is it necessary that the company should offer to its existing shareholders? The answer lies with the pre-emptive rights of the shareholders. Under such pre-emptive rights provision, it reinforces the rights of the shareholders as owners of the company which are entitled under common law to anything of value that the company may distribute which include buying of new issues of securities.

Another aspect of rights issue is that the new shares are offer normally at a lower price than the market price. Why is this so? If the company does not price its right issue lower than market price then the shareholder can actually buy the shares in the open market.

So what is the difference between a bonus issue and rights issue?

Let look at the following illustration:

Ex-Bonus Price

Price of share before 1-for-3 bonus issue is announced $4.00

3 existing shares at $4.00 =$12.00

1 new share for FREE = Nil

4 shares are worth =$12.00

Ex-Bonus price equals [$12.00/4] =$3.00

Assuming that instead of offering shareholders a 1-for-3 bonus issue, the company decides to offer the same new shares at $2.00 each.

Ex-Rights Price

3 existing shares at $4.00 cum-rights =$12.00

1 new share at $2.00 =$ 2.00

4 shares are worth =$14.00

Ex-Rights price equals [$14.00/4] =$ 3.50

As illustrated, the calculation of the ex-rights price is exactly the same in principle as that for bonus issue .

The only difference is we have to add in the price of the new share offered by way of rights issue. The “rights” of each shareholder in this case is the opportunity to subscribe for one new share at $2.00 for every three shares already held.

So now we are clear of the difference between bonus issue and rights issue. Simply a bonus issue a new share offer free whilst rights issue are new shares offer to shareholder at a lower price than the market price. Calculation wise the above illustration shows similarity.

As for bonus issue, the reasons have earlier been explained..

Now, let’s turn to the purpose of rights issue. So what do you think would be the rationale/reasons for using the rights issue strategy?

The following reasons might be as follows:

• The company is in dire needs of funds as it has accumulated trading losses for a number of years;

• The company might be under-capitalized or is overtrading hence the need for new cash infusion from its existing shareholders instead of seeking external bank borrowings;

• Rights issue can assist to get the right mix between shareholders and borrowings;

• It need cash infusion for large scale business expansion;

• It need cash to fund another different type of venture/investment;

• Is a cheaper and more convenient source of fund;

• The company’s gearing ratio is already too high and far exceeded bankers’ covenant on gearing ratio dictation;

• Finance costs like interest charges reflected in the Income Statement is very large and rights issue has no explicit interest cost [ though its affect future earning/dividend per share]. This might be part of re-engineering exercise to reduce high interest borrowing costs to bring the company back to profitability;

• Rights issue are cheaper than other types of borrowings;

• It might be the most conducive if the company no longer able to provide assets collaterals to the bankers for additional facilities;

• There might be strict covenants where the company cannot have further borrowings without seeking permission from the existing bankers.

Refer to the following forthcoming articles in my Personal Finance section on Rights Issue pertaining:-

• the types of strategy, a shareholder should do when he/she receives a right issue like (i) to subscribe completely (ii) sells his nil paid rights in the market (iii) sell sufficient nil paid rights to pay for remaining entitlement (iv) sell sufficient shares cum-rights to pay for new shares (v) sell cum rights or lastly shareholder does nothing and

• three basic test the shareholders should look at before the decision whether to take up the rights issue.

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Related Entries

• Bonus Issue:What Is It And Its Purposes/Reasons (Part 1 of 2)
• Cautious with Bonus Issue
• Bonia Proposes Main Board Transfer, 1-for-2 bonus, Share Split
• Bonus Issue – Illustration And Accounting Treatment ( Part 2 of 2)
• AMolek ABORTS Proposed Rights, Bonus Issue