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What is a Rights Issue? How to Look at RIL's Issue?

Co-Founder & Head of Business, Transfin.
May 8, 2020 8:42 AM 6 min read
Editorial

When Reliance Industries Limited (or RIL), India’s first and foremost Unicorn with ₹9Lcr ($119bn) in market capitalisation, decided to raise ₹53,125cr ($7bn) through a Rights Issue, it brought a somewhat traditional fundraising tool back to the front burner, on the way reinvigorating it with some mainstream attention!

So let's dive right into this topic with a guide to what exactly are Rights Issues. And an explainer of RIL's massive Rights Issue and its importance for India's largest company!

Why the Fuss?

The Basics

Before getting into Rights Issues, let us quickly take a step back and remember that there are two ways in which a company can raise capital to fund its growth – Debt and Equity. Debt is borrowing that needs to be paid back (with interest, of course), unless one aspires to end up becoming a gloried wilful defaulter. Equity, on the other hand, is capital in exchange of ownership of part of the company via what is known as…wait for it…shares.

Simple and straight-forward, so far.

With that context, ‘Rights Issue’ is just another way for a company to raise more Equity. More specifically, they are ‘rights’ that are offered to existing Equity owners (or shareholders) to purchase additional shares, typically at a price below the prevailing market price i.e. At a discount. To understand the reason behind this discount, one needs to understand ‘shareholder dilution’. 

Never Dilute!

Whenever a company raises more Equity, it issues new shares. The company’s total shares outstanding hence increases and implicitly decreases the value of existing shares. Think about it: the company’s profitability is now being shared within a larger pool of shares, making each share somewhat less valuable. Now, to somewhat compensate existing shareholders for this ‘dilution’, a Rights Issue incorporates the ability for existing shareholders to buy shares at a discounted price.

The idea is that existing shareholders can, if they want, buy new shares at less than market price and somewhat reduce their potential ‘dilution’.

Finally, there is one last nuance in a Rights Issue. Typically, the number of rights issued to existing shareholders does not take a one-to-one approach, but rather one-to-n i.e. For every 10 shares you own, you might get the right for one share. For instance, in RIL’s case, they are offering the right for one share for every 15 shares. 

What is a Rights Issue? How to Look at RIL's Issue?
‘Rights Issue’ is just another way for a company to raise more Equity. More specifically, they are ‘rights’ that are offered to existing Equity owners (or shareholders) to purchase additional shares, typically at a price below the prevailing market price ie at a discount.

 

What Next?

Once a Rights Issue has been made to shareholders, there are largely three distinct paths one can go down on:

  1. Exercise the Right and purchase the shares at a discount as per the Right’s structure. This way, one ups his/her investment in the company and its future. The existing shareholder’s dilution gets minimised.
  2. Ignore the Rights and take the full dilution hit. While this might appear to be a weak choice, it is possible that an investor just does not have the required cash to actually exercise the Right and buy shares. Remember: the shareholder who is offered these Rights has the ‘right’ but not the obligation to exercise the right.
  3. Sell the Rights to other investors. In this way, the shareholder takes the dilution hit but monetises the rights.

 

The Story of RIL's Debt

The story starts in August 2019 when Mukesh Ambani, Chairman and Managing Director of RIL, had boldly guided the market and investors that RIL is moving towards being ‘Net Debt’ free by March 2021 (Net Debt is nothing but Debt minus cash). At that time, RIL’s Net Debt stood at ₹1,54,478cr ($20.6bn). RIL Chairman's Speech - RIL the Chairman’s statement, which makes for a good read (hint: CTRL+ F for “154,478”).

How to Go Net Debt-Free 101

The way to get to a zero Net Debt company by March 2021 is simple. Bring in ₹1,54,478cr ($20.6bn) in cash by selling some parts of the business or by raising Equity. As identified in the statement, the way to do that broadly involved the following strategic levers.

  • Sell 20% stake in RIL’s oil to chemical business to Saudi Aramco for $15bn i.e. C. ₹1,03,000cr ($13.7bn) at that time.
  • Sell 49% stake in RIL’s fuel retaining business to UK’s BP for ₹7,000cr ($933m).
  • Potentially sell stake in RIL’s consumer business, Jio and Reliance Retail.
  • Other options to extract monetisation value from real estate and other financial and non-financial investments such as cell phone towers etc.

Missing Cash

As things stand, while #1 and #2 have been announced, they are yet to officially close. #1 is currently under due diligence and expected to be somewhat complicated in light of COVDI-19's impact on the Oil and Gas industry. #2 is expected to close sometime this quarter. In any case, they are likely to fetch close to ₹1,10,000cr ($14.6bn) in combined proceeds if they go through. And it turns out #3 was Facebook’s investment for 9.9% Equity stake in Jio fetching ₹43,574cr ($5.8bn).

 

Adding the three i.e. ₹1,03,000cr ($13.7bn) from Saudi Aramco Investment + ₹7,000cr ($933m) from BP Investment + ₹43,574cr ($5.8bn) from Facebook’s Investment = ₹1,53,574cr ($20.48bn). Mighty close to the targeted ₹1,54,478cr ($20.6bn)!

However, since #1 and #2 are yet to officially close and are looming with some uncertainty, other ways to bring in more cash in to the company is perhaps a prudent step. What is possibly a good way to raise cash (remember they can’t raise Debt as it defeats the purpose here of actually paying down Debt)? … Rights Issue!

 

Now What About RIL's Massive Rights Issue?

Last week, RIL announced the plan to raise ₹53,125cr ($7bn) via a Rights Issue. The proceeds of this should drive the well-documented targeted Net Debt reduction and as such this marks the biggest ever Rights Issue by an Indian company!

Here's some perspective:

 

The Biggest List of Rights Issues by Company
(Click here to download the "Databank on Rights Issues in India" for free.)

 

The RIL Issue is priced at ₹1,257 ($16.7), a discount of 14.3% or ₹209 ($2.7) to the closing price on April 30th of ₹1,466 ($19.5). Furthermore, the Rights Issue is for one Equity share for every 15 Equity shares.

Down to the Details

Let us illustrate RIL's big Rights Issue with an example to build intuition around it.

Say an investor owns 90 RIL shares (there are 633.94cr shares outstanding in total). Under this Rights Issue, the investor, who is an existing RIL shareholder, will get 6 Rights or said another way the right to buy 6 more shares at a price of ₹1,257 ($16.7) per share.

Following the Rights Issue, therefore, the investor can own 90+6 = 96 shares!

Let us look at the value.

  • Price of Shares in Market as of April 30th was ₹1,466, which means the value of these shares to the shareholder of 90 RIL shares was ₹1,466 X 90 = ₹1,31,940.
  • The cash outflow for 6 new shares on exercising the rights is: ₹1,257 X 6 = ₹7,542
  • The investor now owns 96 shares which are valued at 96 X ₹1,466 = ₹1,40,736.

Effectively, the value has jumped from ₹1,31,940 to ₹1,40,736 by spending just ₹7,542.

 

However, there is a massive caveat. Since there are more shares in the market now, the value of shares will not remain the same as they were on April 30th. Following the Rights Issue, the price of the shares in market should technically fall ceteris paribus in light of the dilution discussed above.

There are other nuances at play to analyse the merits and demerits of Rights Issues in full. However, a good way to summarise is that Rights Issues help companies in raising more Equity whilst rewarding existing shareholders with an opportunity to increase their shareholding at a discounted price!

FIN.

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