Explaination of Rights Offerings

Here is the nice explanation on Rights Issue picked from a website

Rights Offerings

An often overlooked means of raising new capital is through a rights offerings or rights issuance. Rights issues occur when a firm sells new shares to those investors who have "rights." Rights give their holders the right to buy the new shares at the subscription price. To see how these work, an example is necessary.

The first step is to determine how much the firm needs to raise. For our example suppose a firm needs to raise $50 million dollars. Currently they have 22 million shares outstanding at a price of $25 a share. The next step is to determine a subscription price. The subscription price is the price at which the rights holders purchase the new shares. In this case let the subscription price be $15/share.

In the United States it is common to give a right for each share. So there will be 22 million rights granted. How many shares must you sell?

Number of new shares = (Amount you need to raise) / (subscription price)

So in this case:

$50,000,000/$15=3,333,334 new shares

How many rights will be needed to buy a single new share?

(Number of rights granted) / (Number of shares being sold)

22,000,000 / 3,333,334

6.6 rights / new share

The next logical question is what each right is worth. Unfortunately that is not quite as easy to answer. The first thing that must be done is to calculate the price of the stock after the issue and after the new shares have been sold. To do this we make some assumptions. Notably we assume that the everyone will exercise their rights (we can relax this later but it is generally a very good assumption), and more importantly that the investment opportunities will not change and further that the rights issuance does not change the operations of the firm. If this is true, then pricing is quite simple:

Overall equity value after issuance = Equity value before issuance + amount raised

= (shares * Price) + amount raised

= 22,000,000* $25 + $50,000,000

= $600,000,000



Total number of shares (post issuance)

Number of shares outstanding before the issuance + new shares issued

22,000,000 + 3,333,334

25,333,334

Price per share = new total market value / new number of shares

= $600,000,000 / 25,333,334

= $23.68

Now we can calculate the value of each right.

New price = subscription price + [(number of rights needed) * ( value of each right)]

$ 23.68 = $15.00 + [( 6.6) * (value of each right)]

Solve for the value of each right

Right = $1.315

Note that ex-right price plus value of right = old stock price.

23.68 + 1.315 = 24.995= $25.00

This can also be found by

Right price = (Old price - subscription price) / (number of rights per new share + 1)

=($25.00 - 15.00) / (6.6 + 1)

=($10.00)/(7.6)

= $1.315

If these rights are deemed as transferable, they can be sold on the secondary market. Most rights offerings involve transferable rights.


Link where we can get some more information
http://tutor2u.net/business/finance/finance_sources_equity_rights.asp