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We apply the methodology to Cineworld’s latest fundraise as it asks investors for £1.7bn
Thursday 25 Jan 2018 Author: Daniel Coatsworth

European cinema operator Cineworld (CINE) last week contacted its shareholders to ask if they want to take part in a £1.7bn fundraising to help it buy US rival Regal Entertainment for £2.6bn.

Known as a ‘rights issue’, the exercise involves shareholders making the decision whether or not to buy discounted shares in the group.

Shareholders must take one of four routes. They can either buy some or all of their allocated stock; or they can sell all their rights. They can sell some of their rights and potentially use the proceeds to buy some of the cut-price shares (known as ‘tail swallowing’); or do nothing at all.

We’ll explain the different scenarios in this article which looks at the broader rights issue process and uses Cineworld as a working example.

WHY DO COMPANIES UNDERTAKE RIGHTS ISSUES?

Right issues can be an effective way for companies to raise new money for large acquisitions or strengthen their balance sheet.

The technique has been used by many well-known stocks over the years. For example, Lloyds Banking (LLOY) used a rights issue to raise £13.5bn in 2009. More recently, Tullow Oil (TLW) undertook an approximate £600m rights issue in 2017.

Rights issues aren’t always welcomed by investors with open arms. Their discounted price tends to pull down the market price of a stock, so shareholders typically take a hit to the value of their investment.

Many companies would argue that’s the price to pay to allow their business to grow – and that the longer-term benefits will more than compensate for the short term hit to the value of their shares.

WHAT HAPPENS NEXT IF YOU’RE INVESTED IN A FIRM HOLDING A RIGHTS ISSUE?

You need to ascertain why your investee company is asking for more money. Think about the following scenarios:

Does the desired cash only provide a quick fix to a financial problem and not a permanent solution?

If the rights issue isn’t a permanent solution, you have to consider whether the company can generate the extra cash needed longer term from operations. Or will it have to take more drastic action such as selling assets, borrowing more money or tapping shareholders for more cash?

If the rights issue is to help fund an acquisition, is the acquirer paying the right or wrong price for the target business? Will the acquisition improve its scale? Will it boost or dilute group profit margins?

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Cineworld has faced some criticism that is it paying a very high price for its acquisition of Regal and is taking on too much debt.

The company responded by saying the debt will be at more comfortable levels two years after the deal completes, and that the deal takes it into a new geographic region and creates $100m of
pre-tax synergies a year.


FOUR OPTIONS FOR CINEWORLD INVESTORS AND THE COMPANY’S RIGHTS ISSUE

1. TAKE UP THE RIGHTS

Companies are normally offered the right to buy a set number of shares in proportion to the number they already hold. Cineworld is offering 4 new shares at 157p each for every 1 existing Cineworld share held in the business as at 31 January.

For example, someone with 100 Cineworld shares would have the chance to buy 400 new shares costing £628 in total.

2. SELL ALL OF YOUR RIGHTS

The rights associated with shares in a rights
issue can be traded in the market and have an intrinsic value. These are known as nil-paid shares or nil-paid rights.

Shareholders are able to sell their rights to someone else and receive some money, all without having to sell their existing shares.

It is unlikely that stockbrokers would have the capability to let you trade the rights online, so you will probably have to place an order over the phone.

In order to calculate the price at which the shares could trade after a rights issue, analysts seek to calculate something called the ‘theoretical ex-rights price’.

How does this work? Suppose you owned 100 shares in Cineworld ahead of its rights issue. The market price of the shares stood at 563.5p the day before the ‘four-for-one’ rights issue (i.e. a shareholder could buy four shares for every one they already owned) was announced. The subscription price for the extra shares is set
at 157p.

The value of your holding before the rights issue was announced was £563.50 (100 x 563.5p). If you decide to take up your full allocation, you would have to buy 400 new shares at the new price of 157p each. In that case the amount of cash passing to Cineworld would be £628.

The total value of your Cineworld shares would be £563.50 (your holding pre-rights issue) + £628 (the new shares acquired in the rights issue) = £1,191.50. You would own 500 shares in total.

In order to arrive at the theoretical ex-rights price we have to divide the new total value of the investment by the number of shares you’d own.

In this case £1,191.50 divided by 500 gives you 238.3p as the theoretical ex-rights price. In reality, the share price will also be affected by what motivated the rights issue and the company’s particular circumstances at that time.

If you decide not to take up your allocation, you would still hold 100 shares and they’d be worth the theoretical ex-rights price of 238.3p each. The total value of your holding would be £238.30 which is just over half the value of your shares before the rights issue was announced.

What if you want to sell your rights? The value would be the difference between the ex-rights price and the subscription price which is 81.3p per share in the case of Cineworld (238.3p-157p). Based on our working example, you would receive £325.20 in cash by selling your rights (81.3p x 400 shares).

That would essentially enable you to recoup all of the lost value of your investment, as £238.30 (value of your shares based on the theoretical ex-rights price) + £325.20 (value of selling your rights) = £563.50.

Remember, your investment of 100 shares was worth £563.50 just before the rights issue terms were announced.

3. TAIL SWALLOWING (also known as selling some rights to pay for the cost of some new shares)

An alternative is to sell some of the rights to cover the cost of some of the new shares you buy in the rights issue.

Here, you would sell a sufficient number of the nil paid rights in order to take up the balance of your entitlement under the rights issue, using the net proceeds of the sale of the nil paid rights to enable you to do so.

As a consequence of tail swallowing, you would be required to make no further investment to take up the balance of your rights.

4. DO NOT TAKE UP THE RIGHTS

You could allow your rights to lapse. If the Cineworld share price is below the offer price of 157p on the subscription deadline, the nil-paid rights would expire worthless.

But if they are trading above 157p then you may receive a cash payment per nil-paid share approximately equal to the Cineworld share price less the offer price.

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WHY DOES CINEWORLD WANT TO BUY REGAL?

Cineworld is the second largest cinema chain in Europe with operations in seven countries across Central Europe and Israel. It has been seeking a large acquisition to help it increase scale – and the Regal deal certainly ticks the right boxes.

Regal is the second largest cinema chain in the US. It has 561 cinemas; 7,315 screens; and accounts for approximately 20% of all box office sales in the US. It operates in 43 US states plus some Pacific sites including Saipan and Guam.

The company believes it can achieve $100m of pre-tax synergies a year. Chief executive Moshe Greidinger says examples of cost savings including paying less for screens, projectors and sound equipment, plus reduced corporate and advisory costs as Regal will no longer be listed on the New York Stock Exchange.

There remains some concern in the market that the company is over-stretching its balance sheet in buying Regal. Its ratio of net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) will go from 1.0 times to 4.0 times which is very high.

Greidinger says it will take two years until the ratio is reduced below 3.0, a more comfortable level. The deal is expected to boost earnings in the first full year following completion (2019 financial year).

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