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ZappChai Explainers - What is a Rights Issue?

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Reliance has been the talk of the town for mostly the right reasons! Its Jio Platforms venture is seeing interest from a new foreign investor every other day, most notably from Facebook who acquired close to 10% stake in the business. Today however we focus on another source the firm is tapping into to raise funds as it looks to pare down its debt.

In today's ZappChai Explainer we explain what a rights issue, the rationale for the discounted price and the sale to existing investors, and the implications for shareholders after the rights issue is done.

What is a Rights issue?

A Rights Issue is when a firm raises Equity Capital by selling shares directly to their existing shareholders at a discount. This allows the firm to raise additional capital while allowing the shareholders to remain undiluted.

From time to time firms need to raise capital to support their business. They can do this in two main ways - one raise debt or second issue shares. In today's post, we will be covering one of the ways that firms use to raise equity - Rights issues.

With Equity issuance, there are two broad factors we need to consider - one at what price these shares will be issued, and second who these shares would be offered to. When you are coming out with a new equity issuance in the market, it is likely that you would have to price it at a slight discount to the price it is trading at in the market. This gives investors an incentive to buy shares from the firm instead of the secondary market. But there is a catch. When the firm issues additional shares, the shares of existing shareholders are diluted.

To address this issue, and keep the best interests of their existing shareholders in mind, firms execute what are known as rights issues. Under these, existing shareholders are allowed to buy the newly issued shares at the discounted price, thus keeping their position unchanged.

The Reliance Rights issue for eg, is a 1:15 rights issue, effectively giving existing shareholders the option to purchase one additional share at the discounted rate for every 15 shares they own. After the Rights Issuance is complete, the share price should theoretically move downwards, offset by the increased shares you now hold. Shares that aren't bought by existing shareholders (either because they are unable to, or because they are unwilling to) will be bought by Mr. Ambani, the controlling shareholder.

Implications of the Reliance Rights issue

The rights issue will give the firm access to more than 50K cr of capital that it intends to use to delever. This significantly improves the risk profile of the firm, which has a positive impact on the firm's multiple. The string of positive news around foreign interest, as well as anticipation of the delevering, however has led to a sharp jump in the share price of the firm with the positives quite well priced in.

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