Why You Should Give Some Thought To Flour Mills Nigeria PLC Rights Issue?

FMNSome weeks ago, I received a mail advising me to participate in the Flour Mills Nigeria Rights Issue. I began to think critically about the possible reasons why they may want to go down this route, after all, there are other ways to raise funds. As I gave thought to this pickle, it dawned on me that other people may also be in the same situation – trying to decide whether it is a good idea to participate or not.

 

In this session, we will go through what right issues are, why companies opt for them and options we have as stock market participants. Finally we will have a recap on this subject matter and as usual, this is just my candid view.

 

What are Right Issues (RI)?

When we buy a car, cards or anything else, we essentially own the rights associated with these items provided we are both the legal and beneficial owner (more on these terms later). So if I buy 1 share or 1 million shares of company A’s stocks, I have rights in company A’s business.

RI’s are the stocks that have all but been allocated to existing shareholders of a company, therefore, someone who doesn’t already have stocks in the company cannot buy these shares – this provides a way for existing shareholders to own more shares of the company. With right issues, each shareholder still has the initial shareholding assuming everyone exercises their rights to acquire shares.

Another characteristic of rights issues is they are issued at a discounted price. That means that if the stock price of company A is currently $100 it is possible that the rights issue can be sold to existing shareholders at a 10% discount, or $90 per share.

Third, rights issues usually come like, “four-for-one” or “two-for-five” kind of statements. A four-for-one rights offering means that for every 1 share a shareholder has, he/ she can buy 4 shares extra. Conversely, a two-for-five offering is one that says for every 5 shares that a shareholder has, 2 can be bought.

Fourthly, any shareholder that does not fully exercise his/ her right may find that their share volume as a percentage of the total shares in the market has decreased. This is also known as the shareholder’s shares being diluted. Following on from the example described above, let us try to depict the effect of dilution taking the conditions of the Flour Mills Nigeria (FMN) PLC Rights Issue that are:

  1. The right is offered at a 9% discount (Right Price of N27.00) to stocks current price (as of 9th of February 2018) of N32.60
  2. The right issue is available to current shareholders on the basis of 9 new shares for every 16 shares held at the close of business 8th of  December 2017.
  3. Issued Shares  – 1,476,142,418.00 Ordinary shares of 50 kobo each

For the purpose of this assessment let us assume:

  • the total dividend paid to shareholders in 2017 was N2 per share
  • total number of shares you had in May 2018 was 160 shares and
  • proposed dividend in December 2018 is N2 per share
Year Description Number of Shares Proposed Dividend per Share Total Dividend Income
2017 Opening Shares 160 N2 2 x 160 = N320
2018 Rights not exercised 160 N2 2 x 160 = N320
2018 Rights exercised 160 + 90 = 250 N2 2 x 250 = N500

As you can see, by not exercising your rights to acquire the extra 90 shares in this scenario, you will be denying yourself, N180 (N500 – N320), which you should have pocketed – this is why it is important to think carefully in this investment game.

Finally, with rights issues, if a current shareholder does not want to exercise their right, they can sell that right. This means that if I choose not to buy the shares as an existing shareholder, I can sell my rights in the stock market.

The price or value of the right can be calculated TERP – Discounted price. Where TERP is the “theoretical ex-rights price”.

As of the close of business on 9th February 2018, the price of FMN was N32.60 per share. The rights issue declared was 9-for-16 and was offered at a rights price of N27. If I have 160 shares of the stock, it means I can buy 90 extra shares for a total of N2,430 (90 * N27) excluding charges. The TERP is calculated as:

This means that if I buy the stock, the average value of the Flour Mills stock in my portfolio will be N30.58 based on the stock market close price of N32.60. Deducting the discounted price from this will give me the value of the right issue which in this case is N3.58 (N30.58 – N27) per share.

Why Right Issues?

I am going to be very plain, companies don’t issue rights out of the goodness of their heart and it is usually the management of the company that declares right issues so existing shareholders are not always consulted! The reason for rights issues is so they can raise money from their current shareholders. The question I would be asking if I were a current shareholder is, why do they want to raise money? Do they want to meet current obligations, are they trying to mask an underlying issue in their financial statements or carry out an expansion (e.g. acquisition)? There are various reasons why a company would want to go down the rights issues route and they include:

  1. The company does not want to issue fresh equity as they may be afraid that the market may punish them.
  2. Banks have refused to lend them money due to the high corporate risk etc or their current cost of debt is relatively high or in other words, the company is highly levered (that is high debt level).
  3. They don’t have retained earnings or reserves.

It is important to note we will not be covering these funding channels and why companies may not want to go down these routes in this post. Nonetheless, remember that these are viable options for companies to raise funds.

How Do I respond to Rights Issues?

As a shareholder, I have 3 positions that I can take depending on what I think of the rights issue and they are:

  1. Participate in rights issues by either exercising my entire rights
  2. Selling some or all of my rights in the stock market or
  3. Ignore the rights issues

In this scenario, I am assuming financing my rights issue is not a problem (remember that your capital is at risk as your capital invested can go up or down!) so, I am just trying to make a logical decision on whether I should exercise my rights or not.

If it were me, this is how I would consider my options.

1. Participate in rights issues

For me to participate in the rights issue, I will be considerably comfortable that the management of the company has used their resources so far in a prudent manner. There are various caveats to this and they include but are not limited to:

  • The company was in a bad shape and I bought or still have the stock because I believe in the prospect of the company
  • The company has raised some money but still needs more for an acquisition or expansion

 

In these situations, I have four options:

  1. Exercise all of my rights and give my cash in exchange for the stock of the company or
  2. Sell some of my rights in the stock market and use the proceeds from that sale to fund the purchase of the remainder of my rights! I will only do this only if I am cash strapped because as I mentioned earlier, even though I am saving myself some money, the value of my shareholding in the company will decrease as a percentage of the total stock in the market. But remember, this is my choice.
  3. Sell all my rights and “pocket” my cash. This may sound lucrative but I expose myself to some issues like:
    • My shareholding will be diluted
    • The total value of my portfolio may fall – this can rise, however, if the stock prices pick-up
  4. Sell off all my rights in the offering (and pocket some cash) and all my shares in the company. You may consider this to be extreme, however, if I don’t believe the company’s prospects anymore, why should I still keep the shares let alone buy more?

 

For me, “Option 3” is not on the menu! However, I will go for either Option 1 or 4.

 

2. Ignore the rights issues

For all intent and purpose, if I ignore the rights issues there are quite a few things that could happen to my shareholding:

  • I miss out on the opportunity to get some money if I sell my rights
  • There is the very real risk of my stockholding being diluted. This means:
    • I have a relatively lower voting right (more on this in a later post)
    • If the business begins to make more profits, my returns from shares that I own will reduce relatively. This is because dividends are paid on a per share basis!

Essentially if I do this, I will deliberately be crucifying my investments!!!

 

A Recap of Right Issues…

  • Companies can raise money from rights issues if they neither want to touch retained earnings nor go external (debt or new placements).
  • Rights issues allows existing shareholders retain their current rights and shareholders can sell their rights if they don’t want to use them
  • There is always a specified amount of shares that can be bought or acquired
  • It is cheaper to issue rights than going to the market to make placements
  • It is usually quite successful
  • There is usually a limit to how much a company can raise from this method
  • Before putting your hard earned cash into rights issues, please, please and please, look through the books of the company, ask a financial analyst, ask questions on the forum or contact me to help find out if the stock is worth even holding!!!

 

Till next time I am…

 

Your Investment Analyst

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