Lesson 5 of 7
Rights offerings
A rights offering issues new shares below market price to existing holders, and this shows what a holder loses by doing nothing.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- A rights offering lets existing holders buy new shares below the market price, in proportion to what they already hold.
- The new shares lower the theoretical price of every share, old and new alike, once the offering is complete.
- A right to buy below that new price has a value of its own. A holder who neither exercises nor sells it loses that value for nothing.
A rights offering raises cash by selling new shares to existing holders at a price below where the stock already trades. Because the new shares come in below the old price, the theoretical price of every share falls once they are issued. A holder's right to buy at the lower price is worth something on its own, and doing nothing with it gives that value away.
What the new shares do to the total value
- 100 shares at $20$2,000
- 25 new shares issued at $12+$300
- 125 shares worth= $2,300
The theoretical price after the offering
Before the offering, 100 shares at $20 are worth $2,000 in total. The company issues 25 new shares at $12 each, raising $300. The combined value is now $2,300, spread across 125 shares: $2,300 divided by 125 is $18.40. That $18.40 is the theoretical ex-rights price, the price every share is worth once the new shares exist, whether a holder bought any of them or not.
What one right is worth
A holder needs a certain number of rights to subscribe for one new share, set by the ratio of new shares to old. Here, 100 existing shares support 25 new ones, a ratio of four to one, so four rights buy one new share at $12.
Value of one right equals Ex-rights price − subscription price divided by Rights needed for one new share.
Example($18.40 − $12) ÷ 4 = $1.60
Why doing nothing loses value
A holder can subscribe for new shares, sell the rights to someone else who will, or let the rights expire unused. The first two capture the $1.60 of value each right carries. The third does not. A holder of 100 shares who does nothing goes from $2,000 to $1,840 (100 × $18.40). The $160 lost is exactly the value of the 100 rights that lapsed (100 × $1.60). The new shares are priced attractively enough that doing nothing, not merely declining to buy, is what costs a holder money.
Who is likely to let a right expire
Some holders never read the notice. Some live where the offer is not registered and cannot take part. Some hold rights that cannot be transferred, so the only choices are to subscribe or let them lapse.
Check yourself
A company issues new shares in a rights offering at a price below the current market price. What happens to the theoretical price of one share if a holder does nothing?
- It is unaffected, because the holder bought no new shares
- It falls toward the theoretical ex-rights price, whether the holder participates or not
- It rises, because the company now has more cash
Show the answer
Answer: B.
The ex-rights price applies to every share once the new ones exist. A holder who does not participate still sees it fall.Using 100 shares at $20 before, and 25 new shares issued at $12, what is the theoretical price after the offering?
- $20.00
- $18.40
- $12.00
Show the answer
Answer: B.
$2,000 plus $300 raised is $2,300, divided by 125 total shares, is $18.40.Why does a holder who lets their rights expire unused lose value, rather than simply keeping what they had?
- The right had no value to begin with
- The right was worth the gap between the ex-rights price and the subscription price, and an expired right captures none of it
- Expired rights convert automatically into extra shares
Show the answer
Answer: B.
A right worth $1.60 here is only worth that to a holder who exercises it or sells it. Letting it lapse throws that value away.Sources
- Greenblatt, You Can Be a Stock Market Genius, 1997, on rights offerings as a special situation.
What this leaves out
- Every figure here, $20, $12, 100 shares and 25 new shares, is a round invented input, chosen so the arithmetic can be checked by hand.
- A real rights offering can be transferable or not, and some jurisdictions bar certain holders from receiving rights at all; the terms are set by the specific offering document.
- The ex-rights price assumes the $300 raised is worth $300 inside the company.
- Nothing here is advice about any security.