The Rights Offering and the Retiree's Concentration
Maya Foods Corp. has 100 million shares outstanding, net income of P600 million (EPS P6.00), and trades at P60.00. It announces three things: a cash dividend of P2.00 per share with record date Friday, 15 August; a renounceable 1-for-4 rights offering at P45.00 per new share, with proceeds to fund a plant and expected to earn 5% pre-tax until deployed; and that the rights will be listed and tradable. Your client is a 62-year-old retiree whose P5.1 million portfolio is 80,000 Maya shares (P4.8 million at P60) plus P300,000 cash. She asks whether to subscribe, whether to buy more before the record date to 'lock in' the dividend, and what the rights are worth. She also asks why the price should not simply stay at P60 if the company is 'just issuing more shares.'
1. Compute the theoretical ex-rights price, the theoretical value of one right, and the post-offering EPS and P/E under (a) idle proceeds and (b) 5% pre-tax earnings on the proceeds. State your assumptions.
Read the worked answer
TERP. (4 × P60 + 1 × P45) / 5 = P285 / 5 = P57.00.
Value of one right. TERP − subscription price = P57.00 − P45.00 = P12.00 (theoretical). The client holds 80,000 shares, so she receives 20,000 rights with a theoretical value of P240,000.
Shares after the offer. 100 million + 25 million = 125 million.
(a) Idle proceeds. EPS = P600M / 125M = P4.80. At P57.00, P/E = 57 / 4.80 = 11.9x.
(b) 5% pre-tax on P1.125 billion. Interest = P56.25M. Net income = P656.25M; EPS = 656.25 / 125 = P5.25; P/E = 57 / 5.25 = 10.9x.
Assumptions. No tax on the interest, no plant contribution yet, no change in operating earnings, and no other share issuance. A tax rate on interest would lower (b) slightly. The rights price is a 25% discount to the cum-rights price and a 21% discount to TERP-compensation for dilution, not free value.
2. Explain the record-date/ex-date mechanics under T+2 and evaluate the 'buy before the record date to lock in the dividend' idea.
Read the worked answer
Under T+2, a purchase settles two business days after trade. To be a shareholder of record on Friday, 15 August, a buyer must trade on or before Wednesday, 13 August, so the trade settles on Friday. Thursday, 14 August is therefore the ex-dividend date; a purchase then settles Monday and does not carry the dividend.
'Locking in' is largely illusory. On the ex-date the exchange adjusts the reference price by the dividend, roughly P2.00, so the buyer pays less but receives the dividend-economically neutral before taxes and commissions. The dividend is subject to final withholding tax for an individual, and buying more shares increases concentration and transaction costs.
The rights offering has its own record date; check the timetable separately. She should decide on valuation and suitability, not dividend capture. If she needs cash, selling a small number of shares is simpler and does not increase her position.
3. Assess whether full subscription is suitable for this client and set out the practical alternatives, including the effect of doing nothing.
Read the worked answer
Affordability. Full subscription costs 20,000 × P45 = P900,000, but she has only P300,000 cash. Funding it would require selling other assets or borrowing.
Concentration. Maya is already P4.8 million of a P5.1 million portfolio-about 94%. Adding more would leave a retiree in a single stock with little liquidity. That is unsuitable concentration and liquidity risk.
Alternatives.
- Subscribe to the cash limit: 6,666 rights × P45 = P299,970; sell the remaining 13,334 rights at about P12 = P160,008. She ends with 86,666 shares plus cash.
- Sell all 20,000 rights (about P240,000) and use the proceeds to diversify.
- Do nothing: the rights lapse and she is diluted economically and in voting terms.
Recommendation. Do not borrow. Given the concentration, selling all or most of the rights and diversifying is the more suitable default; if she wants to participate, partial subscription plus sale of the balance. Document her risk profile, the alternatives discussed and her decision. Monitor the rights' market price, since theoretical values move with the share price.