Posted on January 15, 2010 - by Jay
More on Dilution
Photo by MarvinSiefke
Rights issue sucks! Let’s see how this works:
Imagine you are the sole owner of Company ABC. It’s better to think as a sole owner, it makes things clear.
So you put in $10mn capital to start the co. You list the co. and now own 1mn shares of $10 each. ie mkt cap of your co. is $10mn. Then you appointed a CEO to help you run the business. He lost $8mn, well partly bcos of the crisis, partly bcos he was not prudent and expanded to rapidly during the heydays of 2006-07, partly bcos he paid himself and his kakis $1mn over the past few yrs.
The share price plummet to $3, ie mkt cap is now $3mn and the capital is now $2mn. So the CEO announces a rights issue of $10mn, 5mn shares to be issue at $2, that’s 33% discount to today’s price of $3. Do you:
A. Rejoice bcos now you will own 6mn shares of your co. at an average of price $2+ but the share price is $3 (btw you paid $20mn in total, but the value of your co. is now only $12mn)
B. Or you curse the manager for losing most your capital, fire him and sue him in court to try to salvage part of the lost $8mn. Read more…
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January 15, 2010
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createwealth8888 said:
Right issue is suck only if you have no money to stay in the game to prevent dilution. You get diluted. You became a sucker; otherwise, you just continue the game with a higher investment cost and higher risk exposure.
Ask those people who sold their right issue too early for DBS, CPL, KepLand and more.
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January 15, 2010
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AK71 said:
An important question to ask is the reason for the rights issue. If the company is undergoing expansion and the fundamentals and prospects are good, it might be better to go to the shareholders and ask for money rather than to borrow from the banks. That means a lower gearing level and less interest expense. The company does better in time and the market recognises this in the usual way.
We should look at an issue from all angles and avoid tunnel vision.
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January 15, 2010
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8percentpa said:
There are businesses and companies that are so cash generative that the balance sheet is always overflowing with cash. Whatever expansion that is needed can always be funded with internal cashflow.
These are companies that value investors look for.
However, if you do believe in this value investing crap, you can always buy some companies knowing they are gonna do a rights issue, and you get to buy more at a discount to currently already low share prices. And shortly after ex-rights, just sell the shares for some arbitrage profit. It is a good way to make money.
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January 15, 2010
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8percentpa said:
Sorry typo – should read
However, if you do NOT believe in this value investing crap…
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January 16, 2010
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createwealth8888 said:
If a company issue rights, you either subscribe the rights to stay in the game or simply get out.