It is no surprise that retail investors generally dislike rights issues. Every rights issue typically pushes passive investors into making decisions for themselves and creates a rush to look for liquidity.
In this article, I will pen my thoughts on how retail investors can think about rights issues, using the recent IREIT renounceable right issue as a case study.
What is a ‘renounceable rights issue’?
When a REIT manager wants to raise capital to reduce debt or purchase more capital, they may announce a rights issue to raise money from existing investors. The REIT will offer more shares to existing investors often at a price lower than the market price.
Doing this does not lead to a happy event – releasing more shares sometimes mean that investors’ stakes become diluted (% share of the company is reduced) as the rents collected has to be divided over existing shares in the market.
A renounceable right allows an investor to sell these rights to someone else.
A rights issue requires a complex set of decisions :
- Do I wish to keep these rights or sell it to someone else?
- Do I exercise these rights?
Here’s a simple framework to help you decide:
1 – Gather Information
The first step to determine what to do is to collect information on the issue.
For the IREIT rights issue, I collected the following data:
- For every 1000 shares, each investor will receive 454 rights.
- Rights cost $0.49 to exercise.
- In SGX, the rights denominated at 100 shares (Ticker:XC9R) are trading at a price of $0.12.
- Rights denominated at one share (Ticker:IUNR) are trading at is $0.113, but these are available at low liquidity.
- The theoretical ex-rights price is $0.655
2 – Can you afford the rights issue?
Next, check if you can afford to participate in the rights issue.
I have about 160,000 of IREIT shares, and so I would have 72,640 rights (160 muliplied by 454). To fully exercise my rights, I’ll have to find 72,640 x $0.49 or about $35,600. Fortunately, I have enough cash to perform this exercise.
For those who do not have sufficient liquidity, you have no choice but to sell it in the markets. If I do not have liquidity, I would have to unload 72,600 of XC9R at $0.12, collecting $8,712 in the process. I can take my time trying to sell the remaining 40 shares under ticker IUNR, but this amount is trivial and not worth the brokerage fee.
In this case, having a margin account is advantageous as you can borrow funds from the broker to participate in the rights issue.
3 – Should you sell the rights?
Although you can afford the rights issue, sometimes it may still make sense to sell it. Some conditions may include:
- Rights exercise price plus selling price of rights exceeds the cost of buying the REIT directly, which rarely happens in practice.
- Rights exercise price plus selling price of rights exceeds the theoretical ex-rights price (TERP) of the REIT, which means that the REIT is overpriced.
In IREIT’s case, the exercise price of $0.49 plus rights trading price of $0.12, is around $0.61 which means that the REIT is underpriced compared to what it was worth based on earlier analysis, so I will try my best to exercise the rights issue to own the shares, at my nearest ATM.
After you exercise your rights, do you sell the stock?
This is a much harder question to answer. After I exercise my rights, I will have an extra 72,640 shares of IREIT when the shares get credited to my CDP or custodian account a few days after 15 Oct 2020.
For me, I would prefer to diversify my REIT holdings away from IREIT, into an assortment of dividend-paying counters. So as it stands, I will slowly sell my counters over time.
This process will depend on other investments opportunities in the markets. (Which is plenty for dividends investors as everyone seems obsessed with tech stocks at the moment. )
Another question is whether you see any potential in holding onto IREIT. Regardless of your analysis, for IREIT the outcome will depend on how Europe tackles the COVID-19 outbreak. I had analyzed overseas REIT trends, and it does correlate to outbreak management.
Some useful best practices to take note
Good practices to take note of when exercising your rights:
- Bring your documents to the ATM as you’ll need to reference your CDP account.
- Round-up the number of rights to the nearest 100 shares when inputting data, this is free money, and you can often get it from investors who do not exercise their rights and let it go to waste.
- As I manage family funds, I brought my mum to the ATM to show her how it’s done. Doing this is an educational experience for her.
- For margin account holders, your broker will ask you about the issue and execution is seamless.
Final thoughts on renounceable rights issues
In my opinion, less hinges on complicated analyses when you are faced with a rights issue. The exercise is generally set at a much lower price than the market price, and investors are often pressured to sell these rights due to the lack of spare cash.
With very few exceptions (like the case of Data Centre REITS), you are better off exercising your rights to avoid dilution, waiting patiently for the beaten-down REIT counter to recover, and then selling your excess shares to free up your liquidity later.
This entire exercise may take months.
I often see the claim,
“Doing this does not lead to a happy event – releasing more shares sometimes mean that investors’ stakes become diluted (% share of the company is reduced) as the rents collected has to be divided over existing shares in the market”.
This may or may not be true, and requires analysis in each specific case.
In the case of REITS it is generally easier to estimate. Often a REIT will be raising funds to buy income generating property. So, although there are more shares there is also more income to be distributed.
The dilution effect on DPU may not be significant.