Rights Issue and the Ex-Rights Price
Ravensworth plc has 200 million ordinary shares in issue and a current share price of 480p. It reports earnings per share of 32p and a dividend per share of 18p. To fund a £160 million acquisition, it announces a 1-for-4 rights issue at 320p. The acquisition is expected to add £14 million of after-tax earnings in the first full year. A private client holds 12,000 Ravensworth shares and has £9,600 of cash available. She is income-focused and has no other holding in the sector. The client's adviser notes that the theoretical ex-rights price will be below the current market price, and the client asks whether she will lose money by taking up the rights. The broker's fee for taking up the rights is £45; selling the nil-paid rights would cost £60. The market price after the announcement has not yet adjusted.
1. Calculate the theoretical ex-rights price, the value of the nil-paid rights and the client's theoretical position before and after taking up the rights.
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New shares: 200 million x 1/4 = 50 million. Total shares after the issue: 250 million. Proceeds: 50 million x 320p = £160 million.
TERP = [(200m x 480p) + (50m x 320p)] / 250m = [£960m + £160m] / 250m = 448p per share.
Nil-paid value = TERP - subscription price = 448p - 320p = 128p per new share.
The client is entitled to 12,000 / 4 = 3,000 new shares at 320p, costing £9,600.
Before taking up: 12,000 shares at 480p = £57,600, plus £9,600 cash = £67,200 total. After taking up: 15,000 shares at 448p = £67,200. The £45 fee reduces this to £67,155.
The nil-paid rights are worth 3,000 x 128p = £3,840 in theory. If she sells them, she keeps 12,000 shares at 448p = £53,760 plus £3,840 = £57,600 before costs. The rights are not a free bonus; the market price adjusts to reflect dilution.
2. Advise the client whether to take up, sell the nil-paid rights or do nothing, given her income focus and £9,600 cash. Include the effect of the acquisition's expected earnings.
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Taking up preserves her proportionate ownership and avoids the risk of letting the rights lapse. It uses all her available cash and costs £45. Selling the nil-paid rights raises about £3,840 before the £60 fee but leaves her with 12,000 shares out of 250 million, so her percentage ownership falls by 20%. Doing nothing is usually the worst option because the rights may lapse or be sold for her on unfavourable terms.
The acquisition changes the earnings picture. Existing earnings are 200m x 32p = £64 million. Adding £14 million gives £78 million. Post-issue EPS is £78m / 250m = 31.2p, a small fall from 32p. At the TERP of 448p, the P/E is 448 / 31.2 = 14.4x, versus 15.0x before. The issue is therefore mildly dilutive to EPS but not value-destructive in theory.
For an income client, the key question is the dividend. If the company maintains 18p on 15,000 shares, her dividend rises from £2,160 to £2,700, but the payout ratio increases. She should take up only if she is comfortable with the sector concentration and does not need the £9,600 cash. Otherwise, selling the nil-paid rights is the cleaner alternative.