Chapter 20. Rights Issues and Placings

Inoted in chapter 2 that for the most part investors are buying shares on the secondary market: in other words, they are buying shares from other investors. There are occasions, however, where new shares are created and you need to know what action if any to take if a company in which you hold a stake creates new shares.

Rights issue

When a company’s shares are already traded on the stock market but it wants to raise more money, it may ask its current shareholders to stump up cash in return for extra shares. This is called a rights issue because the shareholders have the right to buy more shares if they want to.

It is only fair that existing shareholders are given the opportunity to buy because, as we shall see, rights issue shares are normally issued at a special low price.

Any rights issue proposed by the directors must be approved by a vote of ordinary shareholders at a special meeting. The right to buy shares will be conferred on shareholders who are on the share register on a specific date.

Under a rights issue, the existing shareholders have the right to buy a set number of shares at a set price. Say the rights issue is 1-for-3 at 100p. That means you can buy from the company one new share for every three you already hold and you will pay 100p for each new share that you receive.

The cash goes to the company, usually for a specific purpose such as to make an acquisition or to reduce bank borrowings, but sometimes it is to provide cash in hand for day-to-day running costs or for future needs.

Be sure to read any documents the company sends you regarding a rights issue, because in extreme cases the cash may be needed to stop the company going bankrupt.

The discount

The good news about a rights issue is that the price of the new shares is usually set below the stock market price. After all, if you wanted more shares you could buy them on the stock market, so why on earth would you be tempted to pay the same price or more in a rights issue?

The difference between the rights issue price and the stock market price is called the discount (assuming that, as normal, the rights price is lower). If it is higher, then the rights issue is at a premium to the stock market price.

The size of the discount is decided by the company and it depends on several factors. The more shares on offer, the larger the discount is likely to be. A large discount is referred to as a deep discount.

If you are being asked to buy one new share for every one you already own, then you are being asked to double your stake, in which case you will need a strong incentive in the shape of a deep discount to persuade you to empty your pockets. On the other hand, if one new share is available for every 20 you already own, you may think the extra investment is a drop in the ocean and you will be asked to pay a figure close to the stock market price.

The size of the discount will also depend on how desperate the company is for the cash. If it is, in fact, a life saver because the company is in danger of going under then it will have to offer a very deep discount indeed to persuade the unfortunate shareholders to throw good money after bad.

There is a real skill in getting the rights price spot on. The price has to be low enough to tempt shareholders to pay up, but high enough to raise the amount of cash that is needed.

Underwriting a rights issue

You are not obliged to buy all or any of the shares offered to you in a rights issue. It is your right to buy, not your obligation. The rights issue may, therefore, be underwritten. This means that one or more stockbrokers or institutional investors have agreed to buy any shares scorned by the existing shareholders.

The underwriters will be paid a fee for their pains. After all, if the issue falls flat and few shareholders take up their rights then the underwriters will be forced to stump up the deficit. They could then be stuck with a large holding of shares that are difficult to sell.

If the company is confident of a good take-up by existing shareholders, it will not bother to have the rights issue underwritten, thus saving the cost of the underwriters’ fees.

Shareholders in the company will probably be offered the opportunity to take more than their entitlement so that any rights not taken up can be distributed among those wanting extra. Otherwise any rights shares that are not applied for will be sold by the company through the stock market.

If you decline a rights offer and your entitlement is sold at a higher price than the rights price, the extra cash comes to you, minus the company’s costs.

Say you are entitled to buy 1,000 shares at 100p each. That would cost you £1,000. If you forgo your rights and the shares are sold on the stock market at 150p each, the sale will raise £1,500. The company takes the £1,000 it wanted in the first place and passes the £500 ‘profit’ to you.

It may seem a great idea to be offered cut-price shares, but rights issues are not universally popular with shareholders. You may have made as big an investment as you felt comfortable with and now you are being asked to put up more cash that you may not have readily available.

Also, when a company makes a rights issue, the share price tends to fall to some point between the existing share price and the rights price, so you see the value of your shareholding reduced.

Placing and open offer

Instead of giving existing shareholders the right to buy new shares, a company may offer new shares to institutional investors. This is called a placing. Since the existing shareholders are being bypassed, they will be asked to approve this arrangement, just as they would be required to vote on a rights issue.

There are several benefits, from the company’s point of view, of making a placing rather than a rights issue. First of all, it costs much less. The lower the costs of making the issue, the more of the proceeds go into the company coffers.

Offering shares to a handful of institutions, each taking a large batch of shares, is a good deal cheaper, not to mention faster, than writing to all the shareholders and allocating small parcels of shares to all those who take up the rights.

There is a greater degree of certainty in a placing. The company may already know of institutions wanting to invest.

The placing price can be decided by the company or set through what is known as book building or book running. Institutions and stockbrokers will be asked how many new shares they are prepared to take and what price they are prepared to pay, so demand for shares, and the highest price that they can be sold for, is judged more accurately than taking a guess in a rights issue.

Often, though not always, a placing is accompanied by an open offer. This means that shareholders can apply to buy some of the shares being issued in the placing. They will pay the same price per share as the institutions.

Bonus issues and share splits

There are two other circumstances in which new shares are created but in these cases the shares are allocated automatically to the existing shareholders without payment. They tend to happen when shares are rising strongly; and as a consequence they almost disappeared after the market fell heavily in the wake of the credit crunch.

Bonus issues

Under a bonus issue, as with a rights issue, existing shareholders will be allocated one or more shares for every so many already held. The norm is for one new share for every four or five held, although the exact proportion can vary.

Because shareholders do not have to pay anything, there is no need to apply for bonus shares. As with a rights issue, there will be a specific date on which the bonus issue will apply. Shareholders on the share register on that date get the bonus issue.

Bonus issues are usually made when a company has been trading particularly well and they frankly serve no real purpose except to provide a psychological boost by flagging the good performance. The share price will fall in proportion to the size of the bonus issue. If you get one extra share for every five held then the share price will fall by roughly one fifth, leaving your total holding worth the same amount.

Share splits

In a share split the effect tends to be more dramatic. As with a bonus issue, you get extra shares free but this time you usually get far more. At the very least your shares will be split in two, so you end up with twice as many shares. If the shares are split into five you will have five shares for each one you held previously.

Again, as with the bonus issue, the share price on the stock market is likely to fall accordingly so your total holding will be worth roughly the same.

Share splits are usually introduced after a long upward run in the share price. In this country we tend to prefer share prices somewhere between 100p and 1,000p, in contrast to the US, Europe and Japan where you have fewer but more highly priced shares.

The thinking is that cheaper shares are more marketable. Shareholdings can be sold in smaller batches and the total price will not be so daunting for small shareholders.

This is complete nonsense. If you want to sell part but not all of your shareholding in a company you can split a batch of 100 shares into two parcels of 50 just as easily as you can split a batch of 1,000 shares into two parcels of 500 each, or 10,000 into two lots of 5,000 each.

What splitting the shares does do is to swell the size of the share register, making it more expensive to maintain. For this reason some smaller companies have resisted the convention. Those that have happily allowed their shares to rise well above 2,000p without any obvious signs of indigestion include Johnson Matthey, Royal Dutch Shell, AstraZeneca, Associated British Foods, Imperial Brands and British American Tobacco.

As with a bonus issue, a share split is usually a great psychological boost as it normally signals to the market that all is well, indeed extremely well. So while splitting the shares into, say, five should in theory reduce the price of the shares to a fifth of their former value, in practice they are likely to settle a little higher.

Companies making bonus issues or share splits will not want to suffer the ignominy of seeing the shares fall below the theoretical new price so the directors will be pretty confident about the immediate future for the company.

If you find an error or have any questions, please email us at Thank you!