Rights Issues and Stock Suspensions

Q. Should I take up a rights issue?


A: It is important to understand that you don't have to cough up and buy new shares, unless you want to. However, it is a shareholder's right that they get asked before non-shareholders. If you do not want to invest more money you can always sell your right to buy new shares on the open market. In the event that the open market won't buy all of the new shares, then it's usual practice that the investment bank organizing the rights issue, buys anything left over. So, as far as the issuing company is concerned, their rights issue is guaranteed - they'll sell all their new shares, and get the amount of money from them that they expected. Note that placings are normally at about a 10% to 15% discount to the market price.

Faced with a rights issue you have the following possibilities:

- Invest more cash by taking your full allocation of rights.
- Sell your rights and thus avoid injecting extra cash.
- Sell a portion of your rights and use the monies to buy the remainder which avoids/minimises dilution.
- Do nothing and let the right to lapse thus receiving some cash once the company has sold them on.

Whether you choose to take up a rights issue depends upon your reason for investment in the first place. If you believe that the investment is fundamentally sound, and want to preserve your position, then you may choose to participate. If you are willing to accept a reduction in your position, you can relinquish some or all of your rights to another investor, or you can just sell up completely, accepting that you no longer want to be an investor.

By addressing the financial difficulties the company is facing, a rights issue might actually lower the overall risk of your investment. However, you also need to be aware of the problems facing the company prior to issuing the rights issue as there is a possibility that the capital raised might not prove sufficient to address these problems.

Morgan Stanley's UK equity strategist Graham Secker and his team looked at the 115 largest rights issues in the UK over the past 15 years, and they concluded the best long-term performers are companies that:

- raise a large amount relative to their market value
- have performed poorly in the prior year
- use the cash to repair/strengthen balance sheets

It is worth noting that companies that have been performing well and are raising relatively small sums of cash to fund acquisitions or capital expenditure programs tend to underperform in the long run.

By their nature the price of newly issues shares is fixed and always at a discount to the current market price. A rights issue theoretically at any rate is viable if the undiluted share price is above the new-issue share price.

If the new-issue shares are sold at a discount to the undiluted price, then there will remain a discount after dilution.

Take the simplified example of a company with 1k shares @ £1 each. They issue rights for new shares at 1:1 and 50p each. This gives a theoretical ex-rights price of 75p, valuing the rights (the discount on the new issue shares) at 25p.

If prior to issue, the share price falls to 60p each. Then the ex-rights price becomes 55p each. The rights then become valued at 5p. The rights only become worthless if the undiluted share price falls below the issue price.

This calculation is known as the theoretical ex-rights price (TERP) and it calculated by dividing the new total value of the investment by the number of shares

Q. How do I calculate the theoretical price of the shares after a rights issue?

A: Ok, let's take an hypothetical example of Ladbrokes making a rights issue of 3 shares for every 8 held at a price of 150p each whereby a shareholder can buy 3 new shares for every 8 he already owns. So after the rights issue you will have 3 shares at 150p and 8 shares at 210p (assuming this was the price before the rights issue took effect). This provides 11 shares at 194p (approx.). If the rights issue is considered by the City to be sensible and the markets on a local scale are healthy then there will be a premium to this price. Otherwise they will trade at a discount. If the shares continue trading at the 210p or thereabouts level this will make the new nil paid shares worth 19p each...

Let's take another example to explain TERP (theoretical ex-rights price). Supposing a shareholder holds 100 stocks in ABC Plc. The present price of the stock is presently 110p and the enterprise announces a 1-for-2 rights issue in which a stock holder can acquire one new share for every two he already owns. The subscription price for the extra shares is set at 90p. The value of the investor’s holding before the rights issue was £110 [100 stocks x 110p]. If the investor decides to take up the rights issue he would have to buy 50 shares at the new price of 90p. The investor pays £45 to the company in return for the 50 new shares [50 stocks x 90p]. To compute the theoretical ex-rights price we divide the new total value of the investment by the number of shares. So in this case £155 divided by 150 = 103p.

If the investor decided not to take his rights allocation, he would still continue holding the 100 shares but at the ex-rights price of 103p [that's down £7 on the original holding]. The investor in such a scenario could however sell his rights which would recover much of the £7 book loss. The rights in such instance would be valued on the difference between the subscription price and the ex-rights share price (i.e. 103p minus 90p) = 13p. For 50 shares this would be worth £6.50.

P.S. If a stock price falls to a price inferior to the level at which the rights issue is priced then investors would be better off not exercising their rights as it would be more advantageous to buy stock directly on the exchange.

Q. Can you give me an example of a spreadbet involving a rights issue?

A: Here's one provided by the staff at IG Index involving Lloyds Banking Group plc -:

Lloyds Banking Group plc - Rights Issue Lloyds Banking Group plc have announced a Rights Issue, offering shareholders the right to subscribe for new shares in the company at the rate of 67 new shares for every 50 shares held, at a subscription price of 37p. Terms: Ex Date: 27/11/09

Issue: Rights

Ratio: 67 for 50

Subscription price: 37p

IG Deadline: TBA by email in due course

How will this effect your position?

Positions with Stops: Positions with Stops will have their original positions closed based on the close of business price on the 26 November 2009. A new position will be opened at an adjusted level and size to reflect the above terms. The monetary risk of the trade will remain the same.

Positions without Stops: Positions without Stops will have a new position in the Nil Paid rights booked onto the account on 26 November 2009, at the above ratio at a level of 0. These rights will value at 0 until they are tradable in the market from 27 November 2009.

Clients who are long will have the option to:

- Sell the rights.
- Do nothing. The rights will lapse.
- Take up the rights.
- A decision must be made by the IG deadline.

The default is to lapse the entitlement

Clients who are short will have the option to:

- Buy back the rights to close out the short position.
- Run to expiry and risk being taken up against.
- All positions closed before the ex date will not be entitled or liable to the rights positions.

Q. All I know and care about currently is that in taking up the Ladbrokes rights issue, the rights issue value has increased by almost 30%!!!

A: You can't be up 30% on your investment not when Ladbrokes is currently trading at some 130p!! Recall that Ladbrokes have made a 1 for 2 rights issue at 95p. I think you may have seen that the shares are 30% above the rights issue price and think this is your profit but it isn't. The reason why is that for every share you get at 95p you had to be holding two shares at a much higher price. What about the value of those?? They are lower so you haven't made money.

Look at the scenario in the manner that follows. You obviously had a holding in Ladbrokes prior to the rights issue, say, it was 2000 shares at 150p. That is worth £3000.

They announce a 1 for 2 rights at 95p. You think great, easy money. To get your 1000 shares at 95p you have to cough up an extra £950 and you will end up with 3000 shares.

Those 3000 shares have cost you a total of £3950. When the shares go ex-rights they adjust the price to reflect the extra shares in issue at a lower price. The ex-rights price would be (2*150p + 1*95p)/3 = 131.6p.

Your overall valuation is unchanged. So before the rights you had 2000 shares at 150p = £3000 After the rights you have 2000 shares at 150p (£3000) plus 1000 shares at 95p (£950). So you have 3000 shares valued at 131.6p or (3000 *131.6p) £3950.

Your overall investment in is unchanged. If the shares move up from 131.6p you will be in profit (not from the 95p level). If the shares move below 131.6p you will be losing money. So you need to compare the current share price with the ex-rights price (not the actual rights price of 95p) as this includes your overall investment.

Q. Are investors worse off after a rights issue has been completed?

A: Because new shares in a rights issue are sold at a big discount, a shareholder that takes up their rights completely, should be in the same financial position as before the rights issue - i.e. they shouldn't make a loss, in a grossly simplified world.

For illustration, this is a massively simplified example:

XYZ Plc has 1 billion shares valued at £1 each. Giving a company 'value' of £1bn.

In order to raise cash, it begins a rights issue, to issue 1bn shares at the price of 50p each. We'll assume that there is 100% underwriting.

Following the issue, XYZ plc is now worth £1bn (previous value) + 50p x 1bn (cash from sale of new shares) = £1.5 bn.

As there are now 2bn shares in circulation, they have a fair value of 75p each.

An investor with 1000 shares, worth £1000 - who takes up his right for 1000 shares at £500, will have a shareholding of 2000@75p = £1500. So, although he has invested an additional £500, he hasn't actually made a loss.

If the investor chooses not to take up the issue, then his shares will be diluted by the new ones. He then has the option to sell the right on to another investor. The 'fair' value of the right is 25p per share, but it's a matter of supply and demand. If the market feels the company is a dead duck, then he may end up having to sell his right for a big discount on its 'fair' value.

Q. What is the difference between a placing and a rights issue?

A: In the UK companies are allowed to raise up to 5% of their existing share capital base in cash without giving shareholders rights to buy new shares. This percentage quota is raised to 10% if the money is intended for an acquisition. On the other hand a rights issue has no limit on its size or the extent of the discount offered on newly issued shares so a rights issue is more suitable for bigger capital injections. The fact that a placing is limited in size means that a placing won't likely have a big effect on a company's operations. A rights issue protects shareholders' pre-emption rights as it allows current shareholders to subscribe to the rights issue in proportion to their existing holdings. Placings on the other hand don't come with pre-emption rights so dilute existing shareholdings - for this reason a right issue is often preferable for the retail investor. A problem with rights issue is that it takes about 3 weeks for the administrative process to clear making a rights issue less effective for urgent cash injections.

Q. What happens with spread bets when a rights issues occurs?

A: In a rights issue a company will generally be offering existing shareholders the right to buy a certain number of new shares at a certain predetermined price. This is a method of capital raising by a company, and the shareholders have the right not to take it up i.e. if you were short you would ignore it, and if you were long you would have the right to increase your position at the price on offer. The rights issue will generally be at a price below the market price and should have a dilution effect, meaning that the share price could reasonably be expected to fall, thus moving in your favour. There is no reason why a company would decide to issue shares for free (except in a 'stock split') as this would simply have the effect of diluting the share price and raising no capital.

In broad terms, spread bets are designed to replicate the profit or loss that would arise on a position in the underlying share. Rights issues are a little more complicated then stock splits because the new shares are issued for money. So the value of the company has changed.

Let's take the case of the company which had been worth £1,000,000 to start with - represented by 1,000,000 each worth £1.

If the additional 1,000,000 shares, instead of being issued at 0 had been issued at 50 then our £1,000,000 company has raised an additional £500,000 and is now worth £1,500,000 represented by 2,000,000 shares which will now trade at 75p. So your £10 down bet at 100 would become a £20 down bet at 75. Here your maximum profit if the share goes to 0 has increased from £1,000 to £1,500 (although the company's management will presumably have to work a little harder to get the share price down to zero despite the additional £500,000 cash they have just raised)

Q. What happens if I placed a spread bet and the company is suspended?

Does the bet remain open after suspension or does the spread betting provider automatically close it? And what if the bet expires but the share is still in suspension?

A: If the stock is suspended it doesn't really matter to the spread betting provider as they are not trading the stock, in fact they could still be making a price and taking bets while the stock is suspended, unlike the market where no dealings can take place. They may not show the price over the internet and you may have to telephone to deal. They may take a view of the possible outcome after the suspension, or other spreadbetters may, therefore the price may vary considerably. However, keep in mind that different companies have differing policies:

Spreadex: On the issue of suspended shares, we would simply replicate the actual market, e.g. if a company were to be suspended we would keep them suspended until the share recommences trading or a decision is made on the outcome, i.e. a takeover has gone through, or the company has been placed into administration. Please note that this can often take considerable time and as in the case of Northern Rock (shares suspended at approximately 90p).

Capital Spreads: With regards to your second question regarding the suspension of a share please see section 16.8 of our Terms and Conditions for this:

16.8 If a share is suspended London Capital Group Ltd is entitled to ask for additional margin to cover any liability to the extent that London Capital Group Ltd considers a fair and reasonable price in the circumstances. If a share remains suspended for more than four business days London Capital Group Ltd at its sole discretion may close the bet with reference to the last official price at the time of suspension.

ODL Markets: If you had an open position on equity which subsequently became suspended we would simply leave the position open on your account. You would be unable to trade out of this position until the stock is active in the stock market. We would never just close the position for you.

In the case of a company gone bust as in the recent case of Lehman Brothers which filed for Bankruptcy protection spread betting providers enforced a 100% margin on the stock.

Q. Anyone know what happens if you are holding a short on a company and the share gets suspended?

Just musing on HMV. Looks like the end game could be unfolding for that one.

A: Much depends on whether the stock (HMV or whichever) remains suspended beyond the expiry date on your bet. The spread betting bookie's rules do explain procedures for that situation. If you happen to have a long term bet (say Sept 2011) you might not encounter an expiry date during the period of suspension - but you will have a chunk of margin tied up and annoyingly unavailable to utilise elsewhere. Also need to beware of other types of corporate action that a distressed company might engage in and which could mess up a bet. For example, if the company announces a major rights issue at a discount to the current market price, that might usefully knock the share price down - but someone with a downbet might find themselves deemed to have said yes to the additional shares (because of them being attached to the borrowed stock underlying the bet, and the lender may have taken up the offer), in which case you suddenly find yourself with a bigger size stake - and possibly hit a margin limit in doing so.

Beware however that different spread betting providers have different policies on stock suspensions. Here's a case-study involving Connaught PLC which went in administration in 2010. A punter had a short spreadbet positions with CMC Markets:

'NH just a got a sad email from a punter short of Connaught Plc (CNT:LSE): Last: 16.65, no change, Volume: 0.00

NH: (won't we all miss that ticker?)

NH: he believed

NH: a big pay day was coming

NH: because he was short via a spread betting house

NH: but NO

BE: And, let me guess, the spread betters have told him he’s closed out at the suspension price?

NH: yep


We are writing regarding your spread bet position on Connaught.

The shares underlying this position were suspended from trading on 7 September 2010 and Connaught subsequently entered administration. In these circumstances, CMC Markets is no longer able to quote prices on this instrument and is unlikely to be able to do so in the future. Pursuant to the Spread Betting Terms of Business, we have suspended Connaught from trading and we will close your position at the last available price prior to suspension.'

Connaught PLC Suspension

Just looked at CMC's business terms as I have an account with them. It appears that a suspension can be deemed to be an act of Force Majeure in which case CMC is entitled to close out positions at whatever price they see fit. In this case I imagine that would be 16.65p for the shorts and 0p for the longs. Not encouraging. Why would anyone want to open a short on any stock in that case?

Note: Just to clarify, I sent an e-mail to CMC. They say both shorts and longs were closed out at 16.65p. Obviously this is good news to anyone who had a long position with CMC when it was suspended.

On the other hand IG Index will make a 'reasonable assessment of the market value of the instrument following suspension' before closing any positions. Sounds better to me, but it depends how reasonable their assessment is of course.

Q. I have a query regarding debt-for-equity swaps - how do they impact an existing spread bet?

I ask because the biggest hit I ever took on a spread bet was when I failed to anticipate how a particular (different) corporate action kicked in. Assuming I have a downbet in place, is the debt-for-equity effect on share price regarded as normal market movement? Or is it regarded as exceptional, triggering some unpleasant bookie action? And can a debt-for-equity action extend beyond the willing participants - i.e. can it be voted through in a manner that forces all small holders to relinquish stock - if so how does that affect bettors? Presumably loaned stock would get recalled and bets closed at current quote - or would it likely be at some other price?

A: Debt for equity swaps usually take the form of private placements, and usually aren't big enough to effect the underlying share price. However, if they were they would.

  1. If the swap was sufficiently large then through the straight forward share dilution the share price should drop.
  2. This would be considered a normal market movement unless the company changed the underlying shareholding, then it would be a Corporate Action.
  3. Most things can be forced on small shareholders, however this I would not expect to be a normal course of action. As noted earlier these are usually private placements and do not involve other shareholders.
  4. A rigid view cannot be taken on loaned stock. In the private placement scenario any loaned stock would not be recalled. If this was a Corporate Action, the stock would probably be recalled but re-loaned at the new shape and money.

Q. If I wish to trade a contract not currently showing on the provider's platform can I put in a request?

A: Yes, of course - just let the spread betting firm know either by phone or e-mail in what you are interested in trading in. They will send your request to the trading desk where it will be researched and if it is liquid enough and the spread betting firm has a live feed from the market then they will put it in their system asap.

 ...Continues here - How the FTSE/Dow Future spread bets are priced

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