A rights issue is an invitation to existing shareholders to purchase additional new shares in an entity. This type of issue gives existing shareholders securities called rights. With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date. The entity is giving shareholders a chance to increase their shareholding in the entity at a discount price.
Curro launches massive R1.5bn rights issue as it eyes “lucrative opportunities”
South Africa’s largest JSE-listed independent school operator is launching a massive R1.5bn rights issue to take advantage of the opportunities brought on by lockdowns worldwide. Among Curro Holdings’ expansion plans is a new online school the private education company announced in May. At the time of writing the company’s shares were up 0.11% to R9.01 in volatile trade, still a far cry from its 52-week high of R24.57. Read more.
After an entity has announced the proposed rights issue, the market, and therefore the share price, reacts. Once the rights issue has been made, the shareholder no longer only owns shares; he also holds right certificates that can be traded separately. The shareholder acquires that right for no consideration and therefore does not have a cost. That, however, does not mean that the right does not have a value. The right is a financial asset that must be accounted for.
Before the rights certificates are issued, the shares trade cum-rights (the rights and the shares are still connected). As soon as the rights certificates are issued, the shares are trading at an ex-rights value, and the rights are trading separately. The cum-rights value is split between the ex-rights value and the value of the right. The value of the shares in the financial records must be allocated to the portion attributable only to shares and the portion attributable to the rights.
The above-mentioned values can be determined by using a shareholder’s interest approach. This method assumes that the equity (shareholder’s interest) of an entity represents the value of the shares. The method used most of the time, however, is to refer to the current market value of the shares. This method assumes that the market price of the shares correctly reflects the value. The market value of the shares is not necessarily equal to the carrying amount of the equity of the entity, since buyers and sellers attach certain goodwill to the shares. If the latter method is used, it is necessary to adjust the shares to the fair value immediately before the rights certificates are issued. This value is then split between the ex-rights value and the value of the right.
After the rights certificates have been issued, the holder of the rights can exercise the rights by paying the issue price and therefore taking up the shares. The rights can also be sold to other investors, who can then acquire shares in the entity, by exercising subject to the conditions of the rights issue. If the rights are not exercised, they will expire on the date determined in the rights issue agreement.
An entity receives one right for every 5 ordinary shares held to take up one ordinary share per right at CU1,60 per share. The entity holds 1,600 shares at a fair value of CU1,90 per share immediately before the rights issue.
The current market value (CU1,90) of the shares in the period leading up to the rights issue will price in the value of the rights. The share price at this point effectively reflects the value of the shares and the associated rights.
In the General Ledger at this point you have an investment in shares measured at (1,600 shares x CU1,90) CU3,040. However as soon as the rights are issued the entity will have two investments:
- an investment in the existing shares (now trading without the rights included - ex rights), and
- another investment in the rights to acquire additional shares at a discount.
Estimating the value of the new investment in rights.
For accounting purposes you need to estimate what the value of the rights at this point are. There will be no trading information as yet for the rights ceritifcates. So we start by estimating what each of the components of the 'with rights' value (cum rights) of the existing share price (CU1,90) are. These components, remember, are the value of the rights and the value of the share (excluding the rights - ex rights value). To do this, you start by estimating the value of the share excluding the rights. We do this by assuming that we exercise all the rights we are to receive and recalculate the price per share now that we have 'exercised' the rights.
Next you use either the value per share including the rights (cum rights) or the value per share excluding the rights (ex rights value) to calculate the value per right.
Finally, you determine the total CU value of the rights received, to transfer from the current investment in shares account to the new investment in rights account:
In the General Ledger you now have two investment accounts totaling CU3,040;
- Investment in shares: CU2,960
- Investment in rights: CU80