Rights Issue or Private Placement: What Changes for the Holder

A rights issue offers new shares to every existing shareholder in proportion to what they already hold. A private placement offers them to selected investors instead. Both raise money for the company. The rights route protects each holder's proportion and usually carries the deeper discount; the placement route is faster and hands part of the company to someone new.

What is a rights issue, and how does it differ from a private placement?

Picture four people who together run a snack stall. Each put in a quarter of the money, so each holds a quarter of the stall. The four now need more money for a bigger griddle. If all four put in more, in the same one quarter proportion, the stall gets bigger and each of them still holds exactly a quarter. If instead a fifth person from outside puts in the whole amount, the stall also gets bigger, but the original four now hold less of it than they did.

Nothing dishonest has happened in either version. The two versions answer a different question, and it is only one question: who is allowed to put the new money in.

A rights issueAn offer of new shares made to the people already on the share register, in a fixed proportion to what each of them already holds. is the first version. Harivansh Packaging Limited offers new shares to every holder already on its register, in a fixed ratioThe relationship between new shares offered and shares already held, written as one for three or two for five, and the same for every holder. to what each one holds, at a price the company sets. The offer arrives as a letter, and the letter carries a rights entitlementThe right, and not the obligation, to buy the new shares on the stated terms. Once the offer opens, the entitlement exists separately from the shares., which is the right, and not the obligation, to buy those shares on those terms. A holder can take them, pass the entitlement to somebody else through renunciationHanding an entitlement to another person, either for a payment or for nothing, so that they may subscribe in the holder's place., or do nothing at all and let it lapseAn entitlement that is neither used nor passed on simply expires when the offer closes, and nothing is received for it..

A private placement is the second version, worked through end to end separately. The company decides who may subscribe, agrees the terms with those investors, and issues the shares to them. Nobody on the existing register is asked, and nobody on the existing register can insist on being included.

A rights issue is offered in proportion. If every holder takes it up, not one proportion on the register moves at all, and that is the structural difference. A placement cannot have that property, no matter how it is priced, because the people being offered the shares are not the people already holding them.

Both routes, one amount

A comparison of two routes that raise different amounts is not a comparison, it is two stories. Both routes are therefore sized at the same Rs 1,140 crore against the same company, so every difference below is caused by the route rather than by the size.

The two raises stand comparison. Six crore shares at Rs 190/- is Rs 1,140 crore. Four crore shares at Rs 285/- is Rs 1,140 crore. The two totals match to the rupee, so everything further down can be read as a difference between the routes.

Why is the rights price set so far below the reference price?

Two reasons, and neither of them is about the health of the business.

The first is that a rights offer stays open for a period, and the price in the letter is fixed before that period begins. If the shares can be bought more cheaply elsewhere than the price printed in the letter, nobody will use the letter, and the money does not arrive. A company setting a rights price is therefore buying itself room. At Rs 190/- against an illustrative reference price of Rs 300/-, the offer only stops making sense if the reference price falls by more than 36.67 per cent while the offer is open. A price set at Rs 290/- would have almost no room at all.

The second is that a holder subscribing in proportion stands on both sides of the price. The subscribing holder pays the low price and holds the shares that the low price dilutes. Money moves from one of their pockets into the other. A placement works the other way. The investor paying the discounted price and the holders bearing it are different people, so a placement discount is a genuine transfer and is kept small.

The everyday version is a housing society asking every member to contribute towards re-laying the roof, in proportion to the size of each flat. Every member is charged on the same basis. So whether the society calls it Rs 100/- a square foot or Rs 10/- a square foot changes the arithmetic of the contribution and changes nothing about who ends up holding what.

A deep rights discount is a mechanical choice about keeping an offer alive, and a subscribing holder is on both sides of it, so the depth of that discount says nothing about the company. A deeply discounted letter feels like the opposite when it lands, and acting on that feeling is the error set out below.

What is the theoretical ex-rights price, and where does it come from?

Before the offer, Harivansh Packaging Limited has 18.00 crore shares at an illustrative reference price of Rs 300/-. The Rs 300/- is a cum-rights priceThe price of a share while the entitlement is still attached to it, so that buying the share also buys the right to subscribe., meaning the price of a share that still carries its entitlement attached to it. Multiply out and the whole holding on the register is Rs 5,400 crore.

The offer then brings in 6.00 crore new shares and Rs 1,140 crore of cash. Afterwards the company has the Rs 5,400 crore of whatever it had before plus Rs 1,140 crore of new cash sitting in its bank account. The total is Rs 6,540 crore, spread across 24.00 crore shares. Divide one by the other: Rs 6,540 crore over 24.00 crore shares is Rs 272.50/- a share. The Rs 272.50/- is the theoretical ex-rights priceThe weighted average of the old shares at their reference price and the new shares at the issue price. The number is a construction from arithmetic, not an observed price..

Notice that it is a weighted average and not a simple one. The simple average of Rs 300/- and Rs 190/- is Rs 245/-. The old shares outnumber the new ones three to one, so Rs 245/- is the wrong answer. Weighting each price by the number of shares standing behind it is what produces Rs 272.50/-.

The theoretical ex-rights price is an arithmetic construction from two prices and a ratio, and it is not a forecast of where the share will trade. It is what a share comes to if the only two things that changed were the arrival of Rs 1,140 crore of cash and 6.00 crore of new shares, and if the illustrative Rs 300/- was the right starting point. Neither of those two assumptions is settled. The arithmetic is settled, and the arithmetic is what everything below rests on.

What is a right worth, and why does the share price fall by exactly that much?

On the ex-rights dateThe date from which a share stops carrying the entitlement, so that anyone buying the share from then on does not get the right to subscribe. the share stops carrying its entitlement, and from that morning the entitlement is a separate thing that can be held, used or passed on. So there are two ways to put a value on it, and they had better agree.

Route one starts from the new share. A new share costs Rs 190/- and is worth Rs 272.50/-, so the entitlement to buy one is worth Rs 82.50/-. But that entitlement only reached a holder who was already holding three shares. Spread it across those three and it is Rs 82.50/- over three, or Rs 27.50/- for each share held.

Route two starts from the price. The share was Rs 300/- with its entitlement attached and Rs 272.50/- without it. The difference is Rs 27.50/-.

The two derivations give the same Rs 27.50/-, and that equality is the whole reason the fall on the ex-rights date is not a loss. The Rs 27.50/- did not vanish from the share. The Rs 27.50/- moved out of the share and into the entitlement, and the same holder is holding both. Exchanging a note of Rs 500/- for a Rs 400/- note and a Rs 100/- note leaves two things where there used to be one, and the money is the same.

The split is also why a price chart drawn straight through a rights issue misleads unless it is adjusted, and the adjustment an analyst makes is set out below.

What can a holder do with a rights letter, and what is each response worth?

Take one holder with three shares, worth Rs 900/- at the illustrative Rs 300/-. The letter offers one new share at Rs 190/-. There are three responses and no fourth.

Take up the offer, meaning subscriptionPaying the issue price and accepting the new shares, so that the entitlement is used rather than sold or allowed to expire. in full. The holder pays Rs 190/- and ends with four shares. At Rs 272.50/- those four are worth Rs 1,090/-. So they hold Rs 1,090/- and have paid Rs 190/- to get there. Wealth is Rs 900/-. Nothing gained, nothing lost, and Rs 190/- more of their own money now sits inside the company.

Renounce the entitlement for a payment. The holder receives Rs 82.50/- and keeps three shares, now worth Rs 817.50/-. Add the two together and it is Rs 900/-. Nothing gained, nothing lost, and no new money went in.

Do nothing. The three shares are worth Rs 817.50/- and no Rs 82.50/- ever arrives. Wealth is Rs 817.50/- against the Rs 900/- they started with. The gap is Rs 82.50/-, or 9.17 per cent of the holding.

Two of the three responses leave the holder exactly where they started, and the third is the only one that costs money. It costs money not because of any judgement about the company but because an entitlement that is neither used nor sold simply stops existing when the offer closes.

Which route drops earnings per share further, and does that settle anything?

The money has only just landed, and the comparison stands at the moment of the raise rather than at whatever the money later earns. So profit after tax is Rs 225 crore either way.

Under the placement, 4.00 crore new shares at Rs 285/- take the count to 22.00 crore. Rs 225 crore over 22.00 crore shares is Rs 10.23/-, down from Rs 12.50/-, a fall of 18.18 per cent.

Under the rights issue, 6.00 crore new shares at Rs 190/- take the count to 24.00 crore. Rs 225 crore over 24.00 crore shares is Rs 9.38/-, down from Rs 12.50/-, a fall of 25.0 per cent.

So the rights route reports the worse per share number. And yet the holder who took up the rights offer is exactly where they started, at Rs 900/-. Every holder under the placement watched their proportion of the company fall by 18.18 per cent with no way at all to stop it. The larger reported fall sits with the holder who gave up nothing.

The reason is not subtle once it is said out loud. A deeper issue price collects fewer rupees per share, so the same Rs 1,140 crore has to be cut into more shares, and more shares is a bigger denominator. Earnings per share measures the company divided by a share count and not what any holder ends up holding, and the two pull apart the moment new shares go out at a discount.

How does an analyst make the two earnings per share numbers comparable?

Somebody comparing this year with last year has a problem. Last year's Rs 12.50/- was struck on 18.00 crore shares, and next year's number will be struck on 24.00 crore or on 22.00 crore. Set them side by side untouched and the arrival of new money reads as a collapse in performance. It is not one. The standard repair is to restate the historical per share series on the new basis, by multiplying it by the ratio of the theoretical ex-rights price to the cum-rights price.

For the rights issue that ratio is Rs 272.50/- over Rs 300/-, or 0.9083. Last year's Rs 12.50/- becomes Rs 11.35/- on the new basis, and the fall to Rs 9.38/- is 17.43 per cent rather than 25.0 per cent.

Now do the same on the placement side. The enlarged company carries Rs 6,540 crore across 22.00 crore shares, or Rs 297.27/- a share on the identical weighted average construction. The ratio is Rs 297.27/- over Rs 300/-, or 0.9909. Last year's Rs 12.50/- becomes Rs 12.39/-, and the fall to Rs 10.23/- is 17.43 per cent.

Both routes raised the same Rs 1,140 crore against the same Rs 5,400 crore that was already there, and Rs 1,140 crore over Rs 6,540 crore is 17.43 per cent. So the same 17.43 per cent comes out of both routes. Every bit of the gap between 25.0 per cent and 18.18 per cent was a statement about issue prices and none of it was a statement about the company. Put the series on one basis and the two routes do the same thing to the earnings sitting behind a rupee that was already invested. The only thing left over is who was allowed to put the new money in.

A lender reads the same facts from the other end and reaches a shorter answer. A lender to Harivansh Packaging Limited cares that Rs 1,140 crore of cash lands against borrowings of Rs 740 crore, and cares not at all which route delivered it. Both routes deliver equity, and neither creates a claim that ranks alongside the lender's. The route question belongs to shareholders. The cash question belongs to the lender, and on the cash question the two routes are the same event.

Two cautions on all of this arithmetic. The adjustment ratio is built on the illustrative Rs 300/-, so it is only as good as that starting figure. And the Rs 297.27/- is a construction on the same weighted average basis as the Rs 272.50/-, not an observed or expected trading price for anything.

Which route closes faster, and what does the speed cost?

A placement closes at a point. Terms are agreed with the investors who were approached, the papers are signed, and money and shares change places. Whatever else has to happen around that is set out by the Securities and Exchange Board of India (SEBI) at sebi.gov.in and by the Ministry of Corporate Affairs at mca.gov.in. The shape is what counts. A placement is an event.

A rights offer is not an event but an open periodThe stretch of time during which holders may respond to a rights offer. The length of that period is set by the rules of the market.. Every holder on the register has to be reached and given time to answer, and the terms are fixed before the period begins. The period is the price of proportionality. Nothing can be offered to everybody in proportion without waiting for everybody.

The waiting has a consequence. Through the open period the reference price can move in either direction. The Rs 190/- in the letter cannot move at all. If the price rises, the entitlement is worth more and the offer is easy. If it falls far enough, the letter stops being worth using, and the money the company was counting on does not arrive on the terms it was counting on. The deep discount is the buffer against exactly that. The discount is not information about the company. It is the cost of running an offer across a period rather than at a point.

The placement buys speed and certainty by giving up proportionality, and the rights issue buys proportionality by accepting a period in which its own terms can be overtaken. Neither route is faster in a way that makes it better. The arithmetic prefers neither.

Where does each route leave the promoter and promoter group?

The promoter and promoter group hold 58.0 per cent of Harivansh Packaging Limited, or 10.44 crore of the 18.00 crore shares.

Under the rights issue they are offered 3.48 crore new shares, being one for every three of the 10.44 crore they hold. Taking all of them costs 3.48 crore multiplied by Rs 190/-, or Rs 661.20 crore. Do that, and they hold 13.92 crore of 24.00 crore shares. The proportion is 58.0 per cent, exactly where they were. Do not do it, and they still hold 10.44 crore shares, but now out of 24.00 crore. The proportion is 43.50 per cent. Their share count never moved. The denominator did, and the whole of the effect is in the denominator.

Under the placement as it is built here, the new shares go to investors the company selected from outside the existing register. The promoter and promoter group hold 10.44 crore of 22.00 crore shares, or 47.45 per cent. They were not offered anything, so there is no sum they could have paid to change it.

Worth noticing on the way past: the rest of the register faces the same choice on the same terms. The other 42.0 per cent, being 7.56 crore shares, is offered 2.52 crore new shares at Rs 190/-, or Rs 478.80 crore. Add that to the promoter group's Rs 661.20 crore and it comes to Rs 1,140 crore, the whole raise. Everybody is being asked in proportion, including the largest holder.

A rights issue lets a holder of any size keep their proportion by paying for it, and a placement does not, and that is arithmetic rather than a motive. Why any company would choose either route is a separate question. Only the effect of each route on the numbers is settled.

What do the two routes have in common?

More than a comparison tends to suggest. Both are fresh issues. Both create new shares, and both bring cash into the company rather than moving money between one investor and another. Both take the same Rs 1,140 crore to the same balance sheet, and after both of them Harivansh Packaging Limited carries Rs 6,540 crore across its enlarged share count on the illustrative basis used throughout. Both leave every existing holder with the same number of shares they already had unless that holder does something. Both require the company to pass resolutions and make filings. And both sit inside requirements that are covered separately.

A rights issue and a private placement are two answers to a single question. The question is who is allowed to put the new money in, and every difference above follows from that one.