Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Investors are being asked for money. What’s a placing, rights issue and open offer?
When a company is looking to raise cash to fund an acquisition, build a new project or pay down debt for example, there are several avenues they can take.
Sometimes they will issue bonds, which is a type of loan between a company and an investor. This can be appealing because a company can get money from investors without any changes to ownership or how the company operates.
But it also has the downside of adding debt onto the company’s balance sheet, something which could potentially weigh on that company’s growth prospects down the line when the time comes to repay that money.
CREATING A BUFFER
Another way companies can raise cash is through the stock market. This became the most popular way for companies to raise money when the Covid-19 pandemic started in 2020, as they looked to protect their balance sheets and ensure they had enough funds to weather the storm.
This cash doesn’t need to be repaid and so is appealing for companies, although it is not always popular with existing shareholders as the amount of the company they own is diluted when new shares are issued.
There are three main ways companies raise money via the stock market – placings, open offers and rights issues. We explain what all three mean and provide examples of each.
WHAT IS A PLACING?
A common way for firms to raise cash is through placings.
Placings are where companies, or more accurately their brokers, approach investors and offer them new shares, often at a small discount to the current market price. Once the order book is full and the placing is closed, the firm gets its money and the brokers pocket the fees.
Companies often use this method if they need to raise money quickly – for example when lockdown restrictions were imposed and many businesses’ income fell to zero overnight – because it’s typically the fastest and cheapest way of tapping shareholders for cash.
It’s important to note that placings for larger companies are usually restricted to institutional investors like fund managers, and that it is hard for retail investors to participate.
It’s easier to sell a substantial amount of new shares to a handful of major investors rather than many smaller lots of shares to thousands of individuals.
Another part of the problem when it comes to retail investors is that many hold their shares in nominee accounts, meaning they are invisible to the issuing company as individuals. Without a complete list of retail shareholders, companies can’t offer them equal rights.
GETTING ACCESS TO PLACINGS
One company which provides access for retail investors is PrimaryBid. Investors can download the firm’s app, put in their account details and when a company announces a new share issue with a retail tranche the investor receives an email notification. They can then opt to take part via the app on a first come, first served basis.
As these retail tranches don’t qualify as ‘corporate actions’ – events that need to be approved by shareholders such as stock splits, dividends, mergers and acquisitions, rights issues and spin-offs – ISA and self-invested pension providers are unlikely to make their customers aware of them.
These offers are also typically fully subscribed not long after they are announced at 7am or after the market close because the retail investment community is only given a small allocation of the overall fundraise. Fundraising from retail investors without issuing a prospectus is capped at €8 million (£7.2 million).
WHAT ARE OPEN OFFERS?
Where retail investors can take a more active participation when companies raise cash is through open offers.
Open offers are where a company offers its existing shareholders the right to buy new shares, often at a discount to the market price. In this way, it works very similarly to a rights issue, which we’ll discuss later.
Let’s say you own 400 shares in a company. They announce an open offer of subscription shares, giving you the right to buy one share for every five you own – meaning you could buy up to 80 overall. This is known as the ‘basic entitlement’, a guaranteed offer that can’t be scaled back. And let’s say the company is offering these shares at £1.20 each, rather than the market price of £2. That means you can buy these 80 shares for a total of £96 (a discount of £64 versus buying at the market price).
To take a real-world example, in May 2021 leisure group Revolution Bars (RBG:AIM) announced, in order to help fund its growth post-pandemic, an open offer in which retail investors were offered the right to buy one share for every 25 they owned at a price of 20p per share, a discount of 41.2% compared to the closing price the day before.
IAG RIGHTS ISSUE
British Airways owner International Consolidated Airlines (IAG) is a noteworthy example of a company that raised a hefty sum of money – £2.5 billion – through a rights issue in 2020, or a ‘capital increase’ as the company called it. In this instance, it was increasing its capital, i.e. the amount of money it has, through a rights issue.
Shareholders could buy three shares for every two they already owned.
In these situations, to calculate the price the shares should fall to after a rights issue, analysts seek to calculate the TERP or theoretical ex-rights price.
How does this work? Let’s suppose an investor held 100 shares in IAG ahead of its issue – we’ll use the listing on the Madrid stock exchange as the issue was priced in euros.
The market price of the shares was €2.21 the day before the terms of the issue was announced. The subscription price for the extra shares was set at €0.92.
The value of the investor’s holding before the rights issue was €221 (100 x €2.21). If they decided to take up their full allocation they would have had to buy 150 shares at the new price of €0.92. In that case the amount of cash passing from the investor to IAG would have been €138.
In order to arrive at the TERP we have to divide the new total value of the investment by the number of shares. In this case €359 (€221 + €138) divided by 250 to give €1.44.
WHAT ARE RIGHTS ISSUES?
Similar, but not the same, to an open offer is a rights issue. A rights issue involves shareholders making the decision whether or not to buy discounted shares in a company.
Shareholders must take one of four routes. They can either buy some or all of their allocated stock; can sell all their rights; 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.
Rights issues can be an effective way for companies to raise new money for large acquisitions or strengthen their balance sheet, but they aren’t always welcomed with open arms by investors.
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.
As an investor, when it comes to rights issues it’s key to ascertain why the company is asking for more money. One important question to consider is whether the desired cash only provides 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 whether it will have to take more drastic action such as selling assets, borrowing more money or tapping shareholders for more cash.
As well as strengthening their balance sheet, companies also turn to rights issues to fund acquisitions. In this instance it would be important to consider whether the acquirer is paying the right or wrong price for the target business, whether the acquisition will improve its scale and if it will boost or dilute group profit margins.