What is the impact of rights issue on market price of equity shares?

Question

What is the impact of rights issue on market price of equity shares?

Answer 1

Like the bonus or split, after the rights issue also the market price of the price has to come down according to the ratio of rights issued.

Answer 2

A rights issue dilutes the earnings per share and the equity per share of the outstanding stock in general and therefore has a negative influence on the market price of the shares outstanding.  

There might be one exception to this rule.  That would be a rights offering by a closed end fund that is currently selling below net asset value.  In that particular case the rights increases the amount of capital that can be invested by the fund and since it is selling at a discount to net assets, increases the book value of the fund and should but may not result on a bottom line increase in the value and hence the price of the shares.  That would be particularly true in a market which has had a significant sell off such as the current market.

Answer 3

A rights issue say, 1:1, that is 1 share for every share held would naturally double the number of shares outstanding. The Earnings per share or EPS will thus get halved. The market price will also thus adjust to half its previous levels to reflect this change in earnings per share. So the impact is earnings dilution in the ratio of the bonus issue, and consequently similar negative impact on the market price.

The following example tries to explain this in some detail:

Say Company A had 40 Cr shares outstanding before the rights issue. The rights issue would mean now a base of 80 Cr shares outstanding. Now if the company had Net profits of 4000 Crs, that implies that the Earnings per share or EPS =Net Profits/Shares Outstanding, would naturally become Rs.50 per share after the rights issue; whereas it had reported an EPS of Rs. 100 per share prior to the rights issue.

So, if company A has a normal PE (Price-to-Earnings ratio) band between say 30-35, when the EPS gets to Rs 50 instead of Rs.100 (because of dilution), Company A will start trading in the Price=PE*EPS range of Rs. 1500-1750 (50x30-50x35) , whereas earlier pre-rights it would have been trading at Rs. 3000-3500 (100x30-100x35)!

Hope this rather longish explanation served the purpose!