Is rights issue a scam where promoters gain at the cost of retail investors?

Isn’t it like a Diwali bonanza or in financial terms, a Ponzi scheme?!

A deluge of rights issues raised money from the market in the last couple of years and some more are in the race, which has announced to raise money via the rights issue.  

So, first of all, let us understand why there is a need for a rights issue!

There are two types of capital that companies can use to finance their operations i.e. debt and equity. With debt financing, the company has to repay the amount borrowed with interest but with equity financing, there is no obligation to repay the shareholders.

In a rights issue, the company raises funds by issuing more shares to its existing shareholders.

How do rights issues work?

If you are an existing shareholder of the company, you get the ‘right’ to buy additional shares in a certain ratio and at a certain price, which usually is at a discounted rate from the current market price. For example, a 5:1 issue means that you get the right to buy one share for every five shares you own. Rights are offered to only those shareholders whose names exist on the register of shareholders of the company on a record date, which usually happens a few days after shareholders approve the proposal to raise money through rights.

From the above description, I’m sure you must have got a clear idea about the rights issue. However, the crux of the article is that beyond the rights issue, it delves deep into how some of the promoters are acquiring stocks for free at the cost of retail investors.

Usually, the rights issue is offered at a discount but there is no specified limit that a company can offer a discount on its rights issue. 

So, here comes a big loophole!

Shares are offered at a reasonable discounted rate, let’s say, Reliance Industries, which offered a discount of nearly 14 per cent while Bharti Airtel offered a discount of 26 per cent. However, if the right issue is launched at a deep discount compared to its current market price at that moment as a shareholder, one must raise an eyebrow!

Beat The Street (BeatTheStreet10), an independent market research organisation, who is closely tracking corporate governance in Indian markets and has the eye of an eagle with respect to the proceeding of rights issue posted and also inform us about an incident wherein promoters would have gained a whopping 20 crore from the rights issue.

They shared a case of Sandur Manganese & Iron Ores, whose stock price was around Rs 4,000 when the company said that it would issue two right shares at Rs 10 each for every one share held in the company. Now, imagine that you are getting a share worth Rs 4,000 at Rs 10 each that to not a single share but two! Isn’t it like a Diwali bonanza or in financial terms, a Ponzi scheme?!

Coming back to the topic, the ex-right price of a share is roughly estimated to trade around Rs 1,340. So, let us assume that you, as a shareholder, did not apply for the rights issue, then the share price for you would remain at Rs 1,340. So, you lose around 66 per cent of the value of your holding in the stock. On the other hand, if the promoters applied for an additional right issue, they have got Rs 1340 worth of share for just Rs 10 as highlighted by Beat The Street. Here is a table explaining the nitty-gritty of the calculation wherein, SHP stands for ownership.

So, from 18 crore right issue promoter actually made 20 crore, an amount equal to 10-year remuneration of promoters of the company.

Before summing up, let’s have a quick glance - Rights are an option that a shareholder may or may not exercise. However, guiding investors and creating awareness among the investors is always the first priority of our organisation. So, investors have two options

1. Apply for right issue which is complex process, which many investors are not aware.

2. Sell right entitlement which is credited to your demat account during right issue period whose aggregated value will be equal to right issue differential amount.