What Is Rights Issue?

Rights Issue Explained with Example of Bharti Airtel Rights Issue

Introduction

In this article, we are going to discuss What is Rights Issue? Why does a company go for it? What is the effect of rights issue on the comapny and its shareholders? Lets also look at the details of Bharti Airtel Rights Issue.

Company Profile

Bharti Airtel Limited also known as Airtel is an Indian global telecommunications services company based in Delhi, India.
It is Asia’s leading integrated telecom services provider which operates in 20 countries across South Asia and Africa. Airtel provides GSM, 3G, 4G LTE mobile services, fixed line broadband and voice services depending upon the country of operation.
Bharti Airtel Ltd. is a Large Cap Company with a market capitalization of Rs.1,62,396 Crore.

Sources of Raising Money for a Company

1.Initial Public Offering (IPO)

An initial public offering is when a private company or corporation raises equity capital by offering its stock to the public for the first time. It could be a new, young company or an old company which decides to be listed (to become publicly traded) on an exchange and hence goes public.

2.Rights Issue

A rights issue is a way by which a listed company can raise additional capital. However, instead of going to the public, the company gives its existing shareholders the right to subscribe to newly issued shares in proportion to their existing holdings.

3.Follow-on Public Offer (FPO)

If even after Rights Issue, the company couldn’t raise the capital or still has more capital requirement then the company can use the FPO source to raise funds.

Rights issue is particularly related to equity shareholders. A rights issue is an invitation to existing shareholders to purchase additional new shares in the company.
Thus the company gives its existing shareholders the right but not the obligation to subscribe to newly issued shares in proportion to their existing holdings, at a discount to the current market price.
It is used for raising of equity funds when a company need additional capital. Thus, the company undertakes a rights issue when it needs cash for various objectives.
For Example – 2:5 Rights Issue means an existing shareholder can buy two extra shares for every five shares already held by him/her. And the price at which the new shares are issued by way of rights issue is discounted to the current market price.
It is beneficial for the existing shareholders as they get additional rights (shares) at a discounted price.

Why Does A Company Go For The Right Issue?

There are 2 reasons :

1.When A Company is Cash-Strapped :

If the Debt of the company has become very high and it is not in a position to raise more debt then that company can do Rights Issue.
In such case, the company goes to the existing shareholders and ask them whether they are interested in some extra shares at a discounted rate. Not all existing shareholders are interested, but some shareholders are interested in the subscription and thus right shares are issued.
This is exactly what is happening in the telecom sector. The companies in the telecom sector don’t want raise any more debt.
The D/E ratio of Bharti Airtel is close to 1.60 and the company does want to raise any more debt. Thus, the company has declared Rights Issue and is raising capital through equity.

2.When A Company is Looking for Corporate Expansion or Takeover :

Right issue occurs when a company needs funds for its corporate expansion or a large takeover.
To issue right shares, not all companies need to be financially unhealthy. Many companies that have clean balance sheets also go for the rights.By approaching the existing shareholders they raise the capital they need for their growth and expansion.
Since it results in higher equity base for the organisation, it also provides it with better leveraging opportunities. The company becomes more comfortable when it comes to raising debt in the future as its debt-to-equity ratio reduces.

What Is the Effect on the Comapny and the Existing Shareholders?

A rights issue affects two important elements of a company : Equity Capital and Market Capitalisation.

1.Equity Capital :

Since additional equity is raised, the issuing company’s equity base rises to the extent of the issue.
As we have stated above, it results in higher equity base for the company. Thus, right issue provides the company with better leveraging opportunities.

2.Market Capitalization :

The effect on market cap depends on the perception of the market. Every new issue has some kind of diluting effect and hence as a result of a fall in the market price in proportion to an increase in the number of shares, the market capitalization remains unaffected.
However, if the market sentiment believes that the funds are being raised for an extremely positive purpose then price of the stock may just rise resulting in an increase in the market capitalization.

Rights Issue – Good or Bad?

Rights Issue is generally done by the companies which are involved in capital intensive sectors. These companies don’t want to increase their debt and that is why choose this method to raise capital through equity.
Good or bad, depends on the whether the promoter is taking part in it or not. If the promoter is taking part in the Rights Issues it can be a positive sign.
It also depends upon the future business prospects of the company.

Bharti Airtel Rights Issue Details

The Rights Issue of Bharti Airtel is going to be open from 3^rd May 2019 to 17^th May 2019.
The share price of Bharti Airtel on 22^nd April (when Rights issue was declared) was around Rs. 350. Bharti Airtel has offered the existing shareholders rights issue at Rs. 220.
After that the company is also going to raise some debt. A structured Rights Issue has been declared by the company.
Bharti Airtel is raising a capital worth Rs. 25,000 Cr through Rights Issue. Even the promoter, Sunil Bharti Mittal, will also be participating in this Issue as an existing shareholder.
Significant equity commitment by promoters indicates confidence in the company’s long-term prospects and aids fund raising from external source

Conclusion :

Share capital increases depending on the rights issue ratio.
The company gets positive cash flow (from financing), which can be used to improve its operations, for corporate expansion or takeover.
EPS gets diluted. Dilution occurs because a rights offering spreads a company’s net profit over a wider number of shares. Thus, the company’s earnings per share, or EPS, decreases as the allocated earnings result in share dilution.
Effective EPS, book value, and other per share metrics decline because of the higher number of shares.
Market price gets adjusted (after book close) after the issuance of right shares.

Notes :

The numbers that are used are approximate and have been rounded for presentation purposes.
We are not in any way saying that this is a bad company, or the stock of this company is bad.
We are also not suggesting anyone to immediately go and buy this stock or invest in the stock markets.
Only an analysis has been presented here. No judgments or final statements are being made here.