What Is a Rights Offering?
In a rights offering, also called a rights issue, a company distributes subscription rights to current shareholders, entitling each holder to purchase newly issued shares at a fixed price that is usually well below the market price. The rights are allocated pro rata: a 1-for-4 offering, for example, lets an investor buy one new share for every four shares already held. Rights typically expire within two to six weeks of being issued.
The structure is designed to be fair to existing owners. Because everyone receives the same opportunity to buy at the discount, a shareholder who fully exercises keeps the same percentage ownership. In many deals the rights are transferable, so investors who choose not to subscribe can sell their rights in the market and capture some of the discount's value instead of simply being diluted.
How a Rights Offering Works
The subscription price is generally set 20 to 40% below the prevailing share price to ensure the deal succeeds even if the stock falls during the offer period. Analysts compute the theoretical ex-rights price (TERP), the weighted average of the old price and the subscription price, to estimate where the stock should trade once the new shares exist. A steep headline discount often looks much smaller when measured against TERP.
Many rights offerings are backstopped. In a standby underwriting, investment banks agree to purchase any shares that go unsubscribed, guaranteeing the company its proceeds in exchange for a fee. Alternatively, a major shareholder or sponsor may commit to take up the slack. Some deals also include an oversubscription privilege that lets participating holders buy extra shares left behind by investors who declined to take part.
Why Rights Offerings Matter
Rights issues are the default way large European companies raise equity, so bankers covering those markets model them constantly. In the US they are rarer and often carry a stigma, appearing when a company is too stressed or too tightly held for a conventional follow-on, such as during the 2008 to 2009 financial crisis when major banks used enormous rights issues to rebuild their capital bases.
For investors, the decision comes down to exercising the rights or selling them, since letting them lapse forfeits real value. Suppose a stock trades at 10 dollars and holders can buy one new share at 6 dollars for every four owned. The theoretical ex-rights price works out to 9.20 dollars, which makes each right worth about 80 cents, value a shareholder captures only by subscribing or selling.
