The abundance of rights issues by listed corporates in the current calendar year has helped, to some extent, satiate the investors’ appetite for good stocks.

While private limited companies still lack interest in going public — as shown by a handful of initial public offerings (IPOs) in 2020 — rights issues by companies have been generous.

Rights issues, when offered by reputable companies with a record of consistent earnings growth, healthy dividends and an attractive price, have been greeted warmly by stockholders. That is regardless of the fact that the rights issues tend to dilute market prices of such stocks.

A company in need of cash to finance expansion, make debt repayments or pay for working capital can raise funds through a rights issue. Existing shareholders have the first right of acceptance or renunciation of additional shares. Unlike bonus issues, rights shares are offered at a price. In the current calendar year, as many as 20 listed companies have approached shareholders for cash via rights issues. In total, they have generated Rs41.2 billion.

As many as 20 listed companies have generated Rs41.2bn via rights issues in 2020

Arif Habib Ltd Head of Research Tahir Abbas says the companies’ interest in rights offers this year is due to two major reasons: one, high interest rates and the lockdown caused weak financial performance in the first half of the year, which led companies to go for seven rights issues. Two, companies tried to achieve a mix of debt and equity with the equity portion being met by the rights issues.

Corporates also find it easy to go for rights issues as there is no requirement of shareholders’ meetings and mere approval from boards of directors suffices.

Samiullah Tariq, head of research and development at Pakistan Kuwait Investment Company, stated that corporates were issuing rights shares to either fund expansion/working capital or invest in subsidiaries. “While they are also availing TERF and other refinancing facilities, they still need equity to balance the remaining amount.

He observed that lower interest rates had encouraged corporates to initiate expansion, but they also required equity to maintain their leverage ratios. A senior banker concurred that banks look at the debt-to-equity ratio before advancing money for expansion. He agreed that in the low–interest rate scenario, financing through banks would be cheaper than through equity. But companies avoid banks as quick upticks in interest rates can make loans a burden on the balance sheet with financial charges eating into company profits for a long time.

The annual economic survey for 2018-19 had noted that total funds mobilised between July 2018 and March 2019 in the stock exchange amounted to Rs22.4bn compared to Rs14.2bn in the corresponding period in the preceding year. This consisted of capital of new listings totalling Rs1.47bn, debt amount listed totalling Rs14bn and rights issues equating Rs6.88bn. The economic survey for 2019-20 stated that no new company was listed on the stock exchange in July-March 2019-20 compared to two companies in 2018-19. This, it said, implied that companies did not want to take a risk by issuing an IPO during uncertain economic times. The amount mobilised through debts and rights during the period was not mentioned.

On March 16, the Securities and Exchange Commission of Pakistan (SECP) notified regulations called Companies (Further Issue of Shares) Regulations 2020, which stated that the “rights issue” means shares offered by a company to its members strictly in proportion to the shares already held in respective kinds and classes.

The regulations also mentioned conditions for rights issue and the rules that a listed company issuing rights shares was required to comply with. They stipulated that the board would approve the decision to increase share capital and the decision would be communicated on the same day to the SECP and the stock exchange for public dissemination. The decision of the board will clearly state the following: (a) quantum of the issue i.e. as a percentage of existing paid-up capital, (b) issue size, (c) issue price, (d) purpose of the issue, (e) utilisation of the proceeds, (f) benefits of the issue to the company and its shareholders, (g) risks, if any, associated with the issue to which the company and/or its members are exposed to, (h) justification for the issue of shares at premium or discount to face value (if applicable), and (i) where announcement of the issue of bonus and rights shares is made simultaneously, the resolution of the board will specify whether such bonus shares qualify for rights entitlement or not.

A listed company is free to issue rights shares at face value or at premium provided the directors and substantial shareholders of the company undertake in writing that: (a) they would subscribe the rights shares to be offered to them as per their rights entitlement or arrange subscription for the same through other persons. Finally, the regulations provided that “Rights issue once announced by the board of a listed company will not be varied, postponed, withdrawn or cancelled”.

The regulation that now bars companies from calling back the rights share has been greatly to the advantage of stockholders and the market. Previously, dozens of companies tended to announce rights issues at sizeable proportions with the intention to manipulate the price of the company stock. Most of the times, such stocks plunged in the event of such an announcement owing to the expected dilution of prices and the possibility of lower dividend pay-out due to enhanced number of shares.

As shareholders in such companies dumped their holdings, those were picked up mainly by the sponsors and directors at rock-bottom levels. The rights issue would later be cancelled, causing losses to all those shareholders who opted to quit owing to the misleading rights issue announcement.

Published in Dawn, The Business and Finance Weekly, December 14th, 2020