Financial Adviser: 5 Things Every Investor Should Know About Stock Rights Offerings and How to Profit from It
The economic damage brought about by the coronavirus pandemic has pushed many listed companies to strengthen their balance sheet by way of capital raising. Several companies have successfully raised funds last year by borrowings and sale of preferred shares. This year, AC Energy (PSE: ACEN) is also raising P5.4 billion capital by doing a stock rights offering.
What is a stock rights offering
A stock rights offering happens when a listed company plans to raise funds by issuing rights to its shareholders to purchase additional stocks at a discounted price in proportion to their existing holdings.
For example, in the case of ACEN, you may be entitled to buy 1.1 new share of the stock for every stock you hold at only P2.37 per share, which is a 67-percent discount to its current market price of P7.22 per share
The terms of the rights such as the entitlement ratio and discount offered differ for every company. Some may be more generous while others may be less attractive.
How do you know if you should subscribe to a rights offer? What are the terms that you should look for? What will happen to your investment in the company if you choose to ignore the rights offer?
Here are five things every market investor needs to know about stock rights offerings and how to profit from it:
1| Know when you are entitled to buy
Remember that the stock rights offering extends only to shareholders of the company.
In order for you to participate, you need to buy the stock to earn the right to buy additional shares at a discounted price.
There are two important dates that you need to note: the record date and the ex-right date. The record date refers to the date by which investors must be on the company’s shareholder list, who have the right to buy additional shares at a discounted price.
But in order to make it to the record date, you must buy the stock a few days before it. The cut-off date is called the ex-date. Buying the stock after the ex-date will not qualify you anymore to be included in the list by the record date.
For example, in the case of ACEN, it set the ex-rights date last January 8 with the record date on January 13. All investors who hold ACEN shares before the ex-date shall be eligible to the rights and included in the January 13 record date.
2| Know the terms of the rights offer
There are two items that you need to know about the rights offer: the entitlement ratio and the discount.
As a shareholder, you will have the right to buy additional shares in proportion to your holdings at a discounted price.
If you had 110,000 shares of ACEN as of the ex-rights date, you would have earned the right to purchase additional 100,000 shares (110,000 shares divided by 1.1) at discounted price of P2.37 per share.
Imagine if you bought ACEN at a high price last year at P10.10 per share, you would have averaged your cost right now at P5.50 per share if you availed of the stock rights offer.
The average cost of P5.78 per share is computed by first dividing the cost of P10.10 by 1.1 to get P9.18 per share. Add this amount with P2.37 per share to get a total sum of P11.55 and divide it by 2.1 shares to get the average of P5.50 per share.
At average cost of P5.50 per share, you are still up by 31 percent at current market price of the stock, despite the stock’s sharp correction from its high.
3| Know when to exercise your rights
If you are entitled to buy additional shares but you are not interested in the terms of the offer, you have the right to ignore and do nothing. There is no obligation to purchase if you decide not to participate.
However, you need to note that not taking advantage of the discount offered by buying more shares may result to lost opportunities, especially if the stock market is trending higher.
In the same example, if you did not avail of the rights offer and your cost was P10.10 per share, you would have lost already by 28.5 percent at current share price of the stock.
This, of course, assumes that the stock will fall and availing the rights offer can help you lower your average cost, but there are stocks that go higher after the ex-date too.
In this case, if you did not avail of the rights offer, you would also lose the opportunity to earn more.
4| Know that rights are not transferable
Unlike in stock markets overseas, if you don’t like the rights offer, you cannot transfer it in the open market like selling it to other investors who may be interested to buy the rights.
There is no option to monetize the rights into cash if you do not intend to use it because rights are not tradable in the Philippine Stock Exchange. The rights will simply expire if you do not exercise it in time.
The shares that are allocated to you in proportion to your holdings shall be offered to other investors who have used their rights as additional subscription.
Majority shareholders and small investors will have an equal chance of buying the excess shares at a discounted price after the offering.
If you are on the other side of the fence and you want to buy more shares beyond your allocation, this may offer you a good chance to buy stocks at a bargain price.
5| Know the potential value of a stock before you subscribe
Do not subscribe to rights offers for the sake of buying the stock at a discount.
No matter how large the discount is, if the stock has poor fundamentals, the share price will always fall, and even lower than the discounted price.
Normally, the reason why a company conducts a rights offer is to raise funds for expansion. When a company spends capital expenditure, it means that it is investing in the future, which adds value to the stock.
But there are companies that raise funds from shareholders in order to pay existing debts, or finance losing a venture. Paying existing loans by raising money from shareholders does not add value for the business.
The sales generated by the business would still be the same, with only savings from the interest expense as the only benefit.
Similar to buying any Initial Public Offering, it is important that you always review the company’s investment prospectus, where the company normally talks about its plans for the future and how it will use the proceeds from the rights offering.