before being put into effect. Practically, there is little a shareholder needs to worry about except to make a note of the date when the scrip issue is due to take place; otherwise the steep drop in the share price on the day in question may give them an unnecessary shock!
Normally, holders of physical share certificates will be issued with new certificates showing the new number of shares they hold, but shareholders should continue to keep the old certificate because proof of their shareholding is normally based on the old and new certificates together.
Return of capital
A share capital reduction is another name for this exercise. The effect of a return of capital is to leave the shareholder with cash compensation for ending up with fewer shares than they started with.
It is quite common for issuers to achieve a return of capital by replacing existing shares with a new share issue but, for example, only issuing four shares for every five held before. The shareholder will then receive a fifth ‘B’ share that can be cashed in at a future date.
Returns of capital accounts for 2% of all corporate actions. [20 ]
Share buyback – a non-event
Achieving a similar result as return of capital, a share buyback occurs when an issuer buys back its own shares on the open market.
Normally a company would require the approval of a shareholder meeting for such a move but a share buyback is not a true corporate action. This is because the transaction takes place in the stock exchange rather than through formal contact with the shareholders about an entitlement that is proportional to their shareholding.
Both returns of capital and share buybacks have been fairly common in recent years as companies have tended to build up substantial reserves. Shareholders benefit directly from a return of capital while buybacks have an indirect benefit through the support to the share price of an issuer buying its own shares in significant amounts. Share commentators will often contrast actions like these with the launching of takeover bids, an alternative use for piles of cash.
However, share buybacks can be used by a company as a means of a (favoured) major shareholder increasing its holding. The share buyback by Arcelor in 2006 was controversial because the Severstal stake in the company would have risen from 32% to 38% of the shares.
Generally speaking, share buybacks usually result in a small initial increase in the share price. They can eat into a company’s reserves of cash so there may not be funds for increased dividends straight away. Managements can be accused of trying to distract shareholders from poor performance with buybacks.
Shareholders with some capital gains tax allowance to spare mayprefer an issuer to spend its cash on share buybacks rather than on a higher dividend (which will be subject to income tax).
Consolidation
A share consolidation is the opposite to a share split or bonus issue, consisting of the replacement of the shares with a smaller number of shares with a higher face value.
There is no change to the issuer’s market capitalisation, so in a one-for-two consolidation a shareholder would receive half the number of shares but the share price (as well as the face value) would be twice as great.
Rights Issues
One of the most important species of corporate action, rights issues are a method of raising more capital by issuing more shares to existing shareholders in proportion to their shareholdings. As with other share issues, rights issues have to be conducted according to the Listing Rules of the UK Listing Authority. The right to buy new shares in proportion to one’s existing shareholding is known as a pre-emption right or subscription right and, in the UK, it normally requires a resolution to waive the right to be supported by 75% of shareholders. [21]
Clearly, only companies that need more cash will undertake such an exercise and rights issues are often interpreted as an important signal in the stock market. A rights issue confers an extra degree of influence to the shareholders as collectively they have power over the success or failure of the event. In the context of a rights issue, failure would be a widespread disinclination on the part of the shareholders to ‘take up their rights’ (pay for more shares in the company). [22] This not only sends an important negative signal to the market about how shareholders feel about their company, but also means that the issuing company has to look to the open market for buyers of the newly issued shares. Big sale of shares naturally tend to have the effect of forcing the share price downwards.
Companies will normally offer the rights issue of shares to the shareholders at a discount to the current share price in order to encourage the level of take-up. A deeply discounted rights issue was at one time taken as an indicator of the management’s lack of confidence and often heralded a decline of the company’s share price. In recent years deeply discounted rights issues have become more frequent and investors tend to see them as no more than a strategy for ensuring that the rights are all taken up.
Shareholders and analysts will look beyond the corporate action to the ‘narrative’ coming from the issuing company. A rights issue to pay for a convincingly explained acquisition, for example, will find more favour than one launched by an insurance company that has just announced its reserves are insufficient to cover recent claims for hurricane damage. For companies with solvency problems a rights issue may be the only alternative to takeover or liquidation. In these circumstances the shareholders collectively hold the power to decide whether the company survives or not.
As with a company being listed on the stock exchange for the first time, an issuer launching a rights issue would normally use the services of an investment bank in a lead manager role. One of the tasks of a lead manager may be to underwrite the issue or arrange for it to be underwritten by other financial institutions, which means that they will buy the new shares of those shareholders who do not wish to take up their rights. Normally substantial fees are charged for underwriting, which accounts for the significant expenses of a rights issue (see the example below). [The role of the lead manager will be looked at in more detail in Chapter 4.]
FIBERNET GROUP PLC
4 FOR 15 RIGHTS ISSUE TO RAISE APPROXIMATELY £77.0 MILLION
INTRODUCTION
The Board announces a 4 for 15 Rights Issue of 12,826,325 New Ordinary Shares to raise approximately £75.7 million, net of expenses. The Rights Issue has been fully underwritten by Old Mutual Securities.
The Rights Issue is conditional upon, inter alia, Shareholders' approval which will be sought at the Extraordinary General Meeting.
The Rights Issue Price represents a 54.8%. discount to the closing middle market quotation of 1328 per Ordinary Share on 22nd November 2000, the last business day before this announcement.
Rights; tricky terminology
The key defining privilege for the existing shareholders in a rights issue is the opportunity to trade in the new rights issue shares when they are nil-paid, that is before having to pay for them.
Where there are no nil-paid rights to trade the issue is called an open offer but the existing shareholders still have subscription rights. Open offers are the norm in the United States. Sometimes the more helpful term entitlement offer is used.
