QUESTION: When is a right not a privilege? Answer: When it's a rights issue. Shareholders in Hong Kong don't generally like these as it means shelling out more cash. A rights issue is an issue of new shares which existing shareholders have a right to buy. In other words, existing shareholders are given first refusal. It is not what some might envision. A bespectacled corporate face does not bequeath coveted rights on to a supplicating shareholder from an official looking scroll. The company, after all, would not be issuing the shares unless it wanted to raise cash. The move can make more cents for the company than other forms of capital raising. If the company borrows money from a bank, for example, it has to pay interest. Turning to shareholders, on the other hand, means a less onerous cash boost. The reasons for the rights issue also vary depending on the company's needs. The company may use this money to expand the business, take over another company or even reduce its debt. And the size and number of shares will be determined by the amount of cash the company seeks to raise. This of course varies with the project. The issue can come in different forms. A one to three rights issue, for example, means that the shareholders have the right to subscribe for one new share for every three held. One to five means one subscription for five held and so on. But it is not always in the shareholder's best interest to subscribe. Because these shares are usually offered to existing shareholders for less than the market price, shareholders may think they are privy to a deal on the cheap. Before subscribing, however, investors would be wise to bear a few points in mind. As is the case in business, the decision to offer cheaper shares is not based on altruistic reasons. A company offers the shares cheaper because they do not want their shareholders to turn the offer down. It is, after all, better if their own shareholders remain confident in the company in which they have invested. The fact is that shareholders have the choice. As old shareholders, they have the right to accept the offer or sell off their rights to the new cheap shares. Before buying, the shareholder needs to feel confident that purchasing more shares is worth the buy. After a new rights issue, the shares usually trade at somewhere between the price at which the shares were trading before the rights issue was announced and the price of the newly offered cheap shares. The reason for the drop is that some of the value of the old shares are absorbed by the new. But regardless, the investor needs to feel confident enough in the company that he or she does not mind the temporary drop. If for example the rights issue means added growth, the investment may be worthwhile. If the rights issue depresses the way in which investors perceive a share's value, buying more shares may not be the right move. A good guideline is to consider whether you would increase your stake in the company without the rights issue. If you would rather not, you can sell your rights through a stockbroker. These will be sold at the value of the shares at the time you wish to sell. The broker will take a commission on the sale of the rights.
