Rights Issue Strategy for Listed Companies

Background

Rights issue is a primary market offer in which all existing shareholders get an opportunity to acquire additional shares in the company on a pro-rata basis. Every shareholder can use his own discretion while choosing an option to buy shares and may decide to acquire entire or part of the eligible stake while renouncing balance to others.

Though there is no compulsion on any shareholder to subscribe for shares as per his entitlement, often companies offer good discount over prevailing market price and so, usually majority of the shareholders opt for exercising their rights. Any company can raise funds by launching rights issue after complying with the provisions under the Companies Act, 2013, however, if the company is listed on recognised stock exchanges then applicable provisions under multiple SEBI regulations also need to be complied with:

• SEBI Takeover code, 2011
• SEBI LODR Regulation, 2015
• SEBI ICDR Regulations, 2018
• SEBI Buyback Regulations, 2018

Rights issue can be of different types and the company may choose any one or combination of them to suit their requirements while offering an option to all its shareholders:

1. Based on paid up Status

• Fully Paid Right Issue
• Partly Paid Right Issue

2. Based on Renounce ability

• Renounceable Rights Issue 
• Non-Renounceable Rights Issue

3. Based on ICDR Regulations 

• Fast Track Rights Issue 
• Normal Rights Issue > 50 Cr 
• Normal Rights Issue < 50 Cr 

Key Process Outline & Basis of Allotment

The companies can opt for ‘Fast- Track Rights Issue’ of more than Rs.50 crores if the conditions laid down in Regulation 99 of SEBI ICDR Regulations are met and in such cases, SEBI has offered multiple relaxations. Otherwise, following standard process has to be followed by the company for the rights issue:

1. Obtaining approval from the board
2. Appointment of various intermediaries for the issue including lead manager, registrar, banker, legal advisors, advertisement / PR agency, statutory auditors, etc. Underwriter need not be appointed as underwriting is not compulsory.
3. Carrying out due diligence review and legal documentation besides determining offer price
4. Obtaining in-principle approval from the regulator
5. Fixation of record date in consultation with the lead manager
6. Sending abridged letter of offer and application forms
7. Obtaining ASBA facility through bankers
8. Crediting Right Entitlements in demat accounts through depositories
9. Opening of Issue (15-30 days) 
10. Allotment of shares and refund of balance proceeds 

Equity shares will be allotted to eligible shareholders in a pre- determined sequential hierarchy in the following manner:

1. Shareholders to the extent of their entitlement;
2. Renouncees to the extent of their entitlement;
3. If shares are still available then one share to those eligible shareholders having fractional entitlement and who applied for at least 1 additional share;
4. If shares are still available then to those eligible shareholders who applied for additional shares in proportion to their holding as on the record date;
5. If shares are still available then to eligible Renouncees who applied for additional shares;
6. If anything left even after aforesaid allotment then it would be treated as unsubscribed portion of the issue. It is generally distributed among the shareholders and renouncees who have applied for any additional shares.

Normal rights issue of more than Rs. 50 crores may usually take upto 6 months for completion. However, in case of ‘Fast-Track Rights Issue’ or issue having size less than Rs. 50 crores, the process can be completed in a span of around 3 months.

Pricing Mechanism and Impact

The companies have been given complete freedom to determine pricing for the rights issue as per their choice, however, usually significant discount is offered over the prevailing market price in order to reward loyal shareholders and make offer attractive. Given the regulatory approvals required for issuing of shares below face value, traditionally offer price has been at the face value or higher.

Due to discounted price of rights issue, the price of shares gets diluted. Hence, it is likely to go down with the increase in total number of shares after issue. Share price after issue can be estimated mathematically and is called as “Theoretical Ex-Rights Price” (TERP). Following is the formula of TERP:

TERP = [(Existing Shares X Key Process Outline & Basis pital Market Existing Price) + (Rights Shares X Offer Price)] / Total Shares

Value of Right can also be determined as the difference between TERP and offer price using following formula:

Value of Right = TERP – Offer Price Example: XYZ Company announces rights issue of 1:2 i.e.1 share for every 2 shares held at a concessional offer price of Rs.70 while the current market price is Rs. 100. Then, TERP and Value of Right can be calculated as below:

TERP = [(100 X 2) + (70 X 1)] / 3 = 90

Value of Right = 90 – 70 = 20

The shares of XYZ company may trade at ` 90 ex-rights and value of Right will be ` 20. However, it should be noted that this is merely an estimate on the basis of mathematical calculations and actual price may substantially differ based on market sentiments. Further, reduction in price may be temporary and it can even go up if there are good prospects.

Right Entitlements & Options to Shareholders

Rights Entitlements (REs) are the standard rights issued by the company to all its existing shareholders for subscribing to new shares. REs are offered to shareholders on pro-rata basis in proportion with their existing equity shares held as on the record date. If any shareholder is holding shares in physical form then he will have to provide details of his demat account for getting REs.

REs are issued in dematerialised form and have separate ISIN, however, they can be traded in online as well as offline mode. Separate scrip code is issued by stock exchanges for trading of REs and while its opening price is decided by the exchanges, subsequently it is determined by the market dynamics. Anybody can purchase REs and also apply for the rights issue in the given proportion during the issue period. However, if no application is made by the purchaser of REs on or before closing date of issue then such REs will lapse. Once trading in REs stop then it cannot be extended again even if there is an extension of rights issue.

Eligible shareholders can exercise any of the following options as per their discretion during the rights issue:

1. Apply for their rights fully as per their REs
2. Apply for their rights fully as per their REs and also apply for excess rights shares
3. Apply for their rights partly as per their REs and renounce balance REs
4. Apply for their rights partly as per their REs but don’t renounce balance REs
5. Renounce their REs fully 
6. Neither apply for rights shares nor renounce REs 

Advantages of Rights Issue

Since inception, rights issue has been a highly popular fund raisingstrategy which has been beneficial to both the corporates as well as shareholders. Cash-strapped companies can adopt this strategy to mobilize funds when they really need it. Following are key advantages to the companies:

1. Very rare chance of failure
2. Fastest mode of raising capital without incurring any extra debt
3. Economical option wherein costs like underwriting, advertisement, etc can be saved
4. Motivation to existing shareholders due to offer to subscribe shares at discounted rates
5. Preferred mode to attract investors as compared to preferential allotment due to relaxation in lock-in requirements

The shareholders are also benefitted in the event of rights issue as below:

1. Existing shareholders can continue to control the company if rights are not renounced
2. Lucrative option to increase stake at a price lower than prevailing market rates
3. SEBI has permitted shareholders having physical certificates to exercise their rights by providing demat account details
4. SEBI has also allowed usage of R-WAP platform to resident individual shareholders and HUF investors.

The Promoters can also take an advantage to smartly increase their overall stake and control through rights issue:

1. Under SEBI Takeover Code, the Promoters can acquire upto 5% in a financial year, however, through rights issue the Promoters can acquire even beyond 5% without triggering Open Offer under Regulation 3(2) provided issue price is less than ex-rights price.
2. REs can be bought or sold by the Promoters even during Trading Window closure period as per SEBI’s circular dated 23-7-2020.

Recent Relaxation by SEBI 

Due to ongoing Covid-19 pandemic, there is an unprecedented economic crisis resulting into huge scarcity of funds.

Every company has to compulsorily wait for at least 1 year after completion of buyback process as per Regulation 24 of SEBI Buyback Regulations, 2018 if it wishes to raise further capital in any manner including rights issue. However, SEBI has temporarily reduced this timeline from 1 year to 6 months in order to give relief to corporates in view of acute liquidity challenges faced by them.

Further, SEBI has issued various circulars after March 2020 in order to rationalise overall process and gave multiple relaxations to listed companies for mobilising funds through rights issues:

1. Filing of Letter of Offer to SEBI is not required for rights issues upto issue size of ` 50 crores which was earlier limited to Rs.10 crores only
2. Waiver of compulsory 90% minimum subscription criteria, subject to conditions 
3. Conditional relaxation to companies for ‘Fast-Track Rights Issue’ in case of pending show-cause notices provided disclosure is made about potential adverse impact
4. Truncated disclosures by restricting financial statements for last year instead of 3 years

With abovementioned positive measures taken by SEBI, rights issues have now become preferred mode of raising funds. During last few months, more than a dozen big listed companies had successfully completed rights issue process and they also got great response from the investors. Following are few examples of mega issues:

• Reliance Industries – Rs. 53,124 crores
• M&M Financial Services – Rs. 3,089 crores
• Shriram Transport Finance – Rs. 1,500 crores
• Aditya Birla Fashions –Rs. 995 crores