The beauty of a rights offering is that shareholders get treated fairly when a company sells new shares. Or that's the theory.
The practice is often different. Deutsche Bank AG investors take note.
A rights offering sees a company sell new shares at a discount, giving existing shareholders right of first refusal over the additional stock. That protects them from being diluted by outsiders.
What if you can’t afford to stump up the cash? The new issuance will devalue your old shares. But you can ease the pain by selling your rights to buy the cheap stock.
So far, so good. The snag is you won't get a perfect price. Take Deutsche Bank.
The fundraising appears to be going pretty well. The rights were trading on Tuesday morning at about 2.05 euros. The terms of the deal say two rights allow you to buy one new share for 11.65 euros. So buying a share this way would cost 15.75 euros.
That's just a smidgen less than where Deutsche Bank shares were trading. Investors selling their rights don't seem to be getting a bad deal.
But go back to March 3, just before Bloomberg News reported that the lender was considering a capital increase. Then, the stock was trading at 19.63 euros, for a market value of 27 billion euros. Add the 8 billion euros raised in the offering, divide by the enlarged share count, and the shares would be worth 16.97 euros. The value of the two rights required to buy a share at 11.65 euros would be 5.32 euros, so each right should be worth 2.66 euros.
On this (admittedly crude) analysis, Deutsche Bank investors selling their rights aren't getting full value.
This dynamic is common to all rights offerings. There are two factors at work. First: the company may take a long time to generate a decent return on its enlarged equity, lowering the value of the stock. That's clearly the case at Deutsche Bank.
The second reason is the supply-demand imbalance as the company tries to find buyers for all the new securities. This depresses the share price and that of the associated rights. The bigger the discount on the offer, the worse this becomes as more shares have to be issued.
In fact, the Deutsche situation looks pretty benign. Consider Electricite de France SA's 4 billion-euro rights offering, which wraps up today. The French state, which owns 85 percent of EDF, was only willing to contribute 3 billion euros to the fundraising. So it sold the rights attached to about 10 percent of EDF's shares.
EDF said these had a theoretical value of 77 euros each. The government sold them in one go at the beginning of the rights offering for 40 cents apiece -- 86 million euros less than their theoretical value.
Little wonder, then, investors are prone to criticize cash calls for holding them to ransom. They feel they have no choice but to subscribe.
CEOs need to think very hard before they raise equity. Their poor investors have to live with the dilution forever. And bosses should resist pressure from underwriters who argue price isn't important in a rights offering. The depth of the discount matters hugely in practice.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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