Rights (Stock Purchasing)

Rights give stockholders entitlement to purchase new shares issued by the corporation at a predetermined price (normally at a discount to the current market price) in proportion to the number of shares already owned. Rights are issued only for a short period of time, after which they expire.

Also known as subscription rights or share purchase rights.

When a company wants to raise large amount of capital for expansion projects, one of the ways they may get funding is through a rights offering. A company would normally take this route if raising funds through loans is too expensive an option. Also, companies looking to pay off existing debt or to improve their debt to equity ratio may opt for funding through subscription rights given to their shareholders.

Rights issued give first dibs to current shareholders to partake of new shares of the company for a discounted price, before the shares are made available in the public markets. However, the addition of new shares to existing shares in the market creates a share dilution where each share owned is devalued.

For example, Deutsche Bank (DBK.DE) announced a rights offering on March 5, 2017 in a bid to raise approximately €8 billion in capital. The bank planned to issue an estimated 687.5 million shares at a subscription rights price of €11.65 per share. After the last trading day cum rights, Deutsche successfully raised 98.9% of its needed capital from current shareholders who exercised the rights. The company’s shares outstanding also increased from 1.379 billion shares to 2.067 billion shares.

Before the bank made the announcement, its stock was trading on average €17.67 per share and market value was €25 billion. The market value increased by the additional €8 billion raised in the offering to about €33 billion which when divided by the increased no par value shares in the market, reduced the stock value to €33 billion ÷ 2.067 billion shares = €15.97 per share, theoretically.

When a shareholder is given rights, he has a couple of options at his behest. He can take advantage of the offering by exercising the rights given to him. Following the Deutsche example above, consider a shareholder with 100 DBK shares valued at €1,767. The Deutsche offering is a 1-for-2 rights issue (in other words, 2:1 subscription ratio) which means that the shareholder can purchase 50 new shares at a 34% discount of €11.65 per share. If he subscribes to the offering, he will pay €11.65 x 50 = €582.50. His total value per share can be calculated as:

Value of already owned 100 shares = €1,767

Value of additional 50 shares = €582.50

Value of total 150 shares = €1,767 + €582.50 = €2,349.50

Value per share ex-rights = €2,349.50 ÷ 150 = €15.66

While theoretically, his per share value has been diluted, the devaluation of the 100 shares have been offset by the revaluation of the new shares added to the shareholder’s holdings.

Another option a shareholder with rights has is to sell the rights in the market. Renounceable rights have an intrinsic value and can be traded on an exchange just like common shares; on the other hand, non-renounceable rights do not permit the holder to buy or sell on an exchange. The subscription rights issued by Deutsche are renounceable and trade on the German stock exchanges and the New York Stock Exchange (NYSE). Although it is difficult to derive the exact value of the rights, a crude estimate can be gotten. The ex-rights price €15.66 minus the subscription price €11.65 equals €4.01. This is the value of two rights required to purchase one new DBK share. Therefore, each right can be traded for roughly €4.01 ÷ 2 = €2.01.

Finally, a shareholder can purposely choose to let the rights expire for a number of reasons. If he does not have the cash on hand to subscribe to the offering, he may let the rights sit in his account until they become worthless. Also, if the investor has lost hope in the company or does not believe in the project that the company is raising capital for, he may opt to let his rights expire without exercising them.

Shareholders subscribing to the offering, don’t necessarily have to subscribe to all the rights offered. In some cases, a shareholder may only exercise some of the rights to purchase additional discounted shares. The remaining rights, not subscribed to may be sold on the market.

Similar to options, the price of a right is determined by a number of factors, such as its subscription price, the underlying stock price, its volatility, interest rates, and time to expiration. The intrinsic or theoretical value of a right during the cum rights period (when the stock trades with the rights attached) is different from the value of a right during the ex-rights period (when it trades independently).