Rights Offerings

A (very) basic thread on how they work and why they are used

And apologies in advance, this thread is really long so its coming in two parts

(1/x)

So you have stock in a company that just announced a rights offering. What do you do?

First, lets understand what they are

According to Greenblatt :

A rights offering is most commonly used when a company seeks to raise capital. Usually rights are distributed to owners.

(2/x)

These rights, together with cash, allow shareholders to purchase additional shares (usually at a discount).

By giving all shareholders the right (but not the obligation) to buy stock at a discount, a company raises the capital needed while giving owners and equal chance

(3/x)

to buy newly issued stock. This allows existing shareholders to avoid dilution from an equity raise. Alternatively, if shareholders do not wish to participate in the offering they can often sell the rights in the open market

(4/x)

Greenblatt goes on to say rights can be an opportunity, yada yada

What does this mean?

Well for the case of $ICLTF the stock you owned yesterday is now fundamentally changed. You went from owning one share, to now owning one share AND three rights to buy

(5/x)

shares at a discounted price. Those rights are currently "attached" to the common stock meaning they are trading all together (each share now has four components).

In the coming weeks the company is going to spin those rights out to you (tax free). This spin

(6/x)

will have an "ex date" meaning if you buy shares before the ex-date you will also get rights. If you buy a share on or after the ex-date you will no longer get the rights. This is the same in principle as the QRTEA spin / dividends last year.

(7/x)

OK, so you own stock now, you get rights. If you buy stock prior to the ex date you get more rights. If you sell shares prior to the ex date you give the rights away.

Great. I'm getting a bunch of rights - what does that mean?

(8/x)

A right, in form and function, is just like a call option. When you buy a call option, you buy the right to purchase shares on a certain date at a certain price. The call option has value clearly - based in part on the difference btw the exercise price

(9/x)

and the price of the stock and also on the duration (or time left to exercise).

There are two major differences with rights vs calls. The right you get for free (vs buying a call) but expired rights dilute your ownership (which has a cost).

(10/x)

And rights usually don't last very long. In the case of $ICLTF we may only have 30 days to exercise them. What that means is their value is based totally on the difference between where the rights strike (C$1.50) and where the stock is trading after the ex date.

(11/x)

OK, so you get three of these really short term call options, what do you do?

Some questions for you:
1) do you want to own more stock?
2) do you like the exercise price?
3) do you have cash to exercise the right?

If the answer to any is "no" then you have 2 choices

(12/x)

1) Sell your shares
2) Sell your rights (if they trade); if they don't trade you only have one choice, sell your shares

Presumably the rights have value. The more dilutive they are, the more value they *should* have. You don't want them to expire worthless.

(13/x)

Ok but what if you answered "yes"?

In that case you have a few options. Easiest thing to do is just call your broker once the rights hit your account and tell them you want to fully exercise.

For $ICLTF, every share you own gives you three rights that strike at C$1.50

(14/x)

So to fully exercise the rights from one share you would need to have C$4.50 in cash in your account (check your broker for fees too)

If you direct your broker to exercise and you have the cash, when the rights offering is over you'll have C$4.50 less and 3 shares more

(15/x)

There are scenarios in between "yes" and "no" that require other options be considered

Lets say you have a friend (we'll call him MM, random) who owns a bunch of shares already. This person would love to own more at the exercise price and avoid dilution but...

(16/x)

the position is already so big for MM that they don't have the cash to exercise all of their rights? Well in that case you have three options:

1) sell some shares to raise cash to exercise rights
2) sell rights if they trade
3) sell other things to raise cash

(17/x)

All three of those choices are viable - the *best* one is option 2 because it doesn't create taxable sales on shares (but only on the rights). In the case of ICL there may be a market there may not be - we're still waiting to find out.

(18/x)

If we don't know about a market for the rights then what do we do?

Its all about relative value in your portfolio. Before you sell ICL to fund some rights exercises you have to ask yourself what ICL is worth, and therefore what the rights attached to it are worth?

(19/x)

Then compare that value to the market price. If the market for ICL opens up at intrinsic value (including with attached rights) then maybe you trim that to exercise rights. If its cheap, compare it to something else. The *main* point here is you don't want those rights

(20/x)

to expire worthless. Thats free money you're giving to the backstop sponsor. Thats your money - don't give it away. Sell or exercise.

Wait, hold up, backstop sponsor? What?

There are two kinds of rights offerings: backstopped and non-backstopped

(21/x)

A backstopped rights offering is one where a financial sponsor commits to purchase every share that the company needs to issue in the rights offering, but go unexercised by existing owners.

In this case ICL has a large PE firm willing to buy every share ICL needs

(22/x)

to sell to facilitate the purchase of the RYAM assets.

Wait, Mike, why is that important?

In nearly every acquisition I'm familiar with, the seller requires committed funding to sign an acquisition agreement.

(23/x)

In that case, non-backstopped rights offerings are a non starter because its far from certain every shareholder will chose to exercise their rights.

In comes the sponsor. They get all the discounted shares AND they typically get a fee. The ICL sponsor

(24/x)