In the high-stakes world of electric vehicle (EV) battery manufacturing, capital is the lifeblood that powers research, production, and expansion. One strategic move for these companies to secure the capital needed for growth without taking on debt is through a Rights Issues.
This financial instrument is particularly suited to industries like EV battery manufacturing, where the market is expanding rapidly, and the need for investment in new technologies is constant.
Understanding Rights Issues
A rights issue is a way for companies to raise additional capital by giving existing shareholders the right to purchase additional shares at a discount to the current market price within a fixed period. This preferential treatment incentivizes shareholders to increase their investment in the company, aligning with their interest in its growth.
Benefits of a Rights Issue
The primary benefit of a rights issue is that it allows companies to raise capital while avoiding or reducing debt and interest costs. It also demonstrates confidence in the business’s future by offering shares to those who already have a vested interest — the current shareholders. Moreover, because the offer is made to existing shareholders, the company can save on underwriting fees associated with public offerings.
Selection of Issue Quantity
Deciding on the number of shares to issue is a critical strategic decision. The quantity should align with the capital required for specific growth plans without diluting the stock too much, which could negatively impact share prices. The company needs to balance between raising enough capital for expansion and maintaining shareholder value.
Market Price After Issue
The market price of shares after a rights issue may decrease due to the increased number of shares available. However, if the market perceives the rights issue positively and the reasons for raising capital as beneficial for future growth, it can have a minimal impact or even lead to an increase in share price over time.
Pre-emption: Safeguarding Shareholder Interests
To protect shareholders, the concept of ‘pre-emption rights’ comes into play, a crucial aspect in the corporate finance world, especially in sectors like EV batteries where the pace of growth is exponential.
What Are Pre-emption Rights?
Pre-emption rights grant existing shareholders the first refusal on new share issues, allowing them to maintain their proportional ownership in the company. This right ensures that shareholders have the opportunity to purchase additional shares before the company offers them to external investors, thereby preventing the dilution of their stake.
Legal Protection of Pre-emption Rights
Pre-emption rights are not just a corporate courtesy; they are enshrined in law. This legal backing gives shareholders confidence that their investment is protected and that they will not be unfairly disadvantaged by the issuance of new shares. It also ensures that any waiver of these rights can only occur with the shareholders’ explicit consent, usually obtained through a special resolution at a general meeting.
Issue Price Considerations
It’s a delicate balance — the price must be attractive enough to ensure shareholder participation but not so low as to excessively dilute the value of existing shares. This balance is particularly important in the electric vehicle (EV) battery sector, which is marked by rapid innovation and growth.
Real-Life Example from the Indian Market
Take, for example, a hypothetical scenario involving ‘ElectroCell Technologies’, an Indian EV battery manufacturer. Suppose ElectroCell Technologies announces a rights issue to fund the development of a new battery technology that could significantly reduce charging times for electric vehicles.
The company’s shares are currently trading at INR 500. After careful consideration, ElectroCell decides to set the rights issue price at INR 450 per share. This price represents a 10% discount to the current market price, which is substantial enough to incentivize shareholders to participate but not so steep as to cause concern about over-dilution.
The Market Response
The market’s response to a rights issue price is often immediate. If ElectroCell’s shareholders perceive the issue price of INR 450 as fair, given the potential growth prospects of the new technology, they are likely to subscribe to the issue. As a result, the company secures the necessary capital, and the market maintains its confidence in the value of ElectroCell’s shares.
However, if shareholders feel the discount is too small, they may choose not to exercise their rights, leading to an unsuccessful issue. Conversely, if the discount is too large, it could lead to a negative market reaction, with the share price potentially falling below the issue price post-announcement.
Calculation of Share Quantity
The quantity should reflect the company’s funding needs while taking into account the dilutive effect on existing shares. Let’s delve into a hypothetical example to illustrate how a company might approach this decision.
ElectroCell Technologies’ Strategic Expansion Plan
ElectroCell Technologies, aiming to fund its next-generation battery technology, estimates it requires INR 1 billion. With the issue price set at INR 450, the company works backward to determine the number of shares to be issued:
Funding Required / Issue Price = Number of Shares to Issue
INR 1 billion / INR 450 = 2,222,222 shares
Balancing Dilution with Financial Needs
ElectroCell must consider the dilutive effect of issuing 2.22 million new shares. The company has 10 million shares outstanding, and the new issue will increase the total to 12.22 million shares. The management must evaluate how this dilution will affect key financial metrics such as earnings per share (EPS) and dividend per share (DPS).
If ElectroCell has a current EPS of INR 50 and DPS of INR 10, issuing more shares would naturally decrease these ratios unless the capital raised significantly boosts earnings.
Determining the Rights Issue Terms
With the funding requirement and issue price set, ElectroCell calculates the rights issue terms. The simplest term that corresponds to the quantity of new shares is determined:
Existing Shares / New Shares = Rights Issue Ratio
10 million / 2.22 million ≈ 4.5
ElectroCell rounds this to a simple ratio for ease of understanding and execution: a 1 for 4 rights issue. This means for every four shares an investor holds, they have the right to purchase one additional share at the issue price of INR 450.
Explore Further : Learn EV Market Now: Different Types of Equity Shares
Market Dynamics Post-Rights Issue
When ElectroCell Technologies announces its rights issue, it’s common for the market to react.
Anticipating Market Reaction
As ElectroCell Technologies announces a rights issue with an issue price set at INR 450 against a market price of INR 500, several market reactions can be anticipated:
- Initial Price Adjustment: The market will try to anticipate the new equilibrium price reflecting the upcoming increase in share numbers and the discounted issue price. This often results in an immediate but temporary drop in the company’s stock price.
- Investor Sentiment: If investors believe the capital raised will significantly enhance future profits, the drop may be less pronounced. Conversely, if there’s skepticism about the new technology’s profitability, the price may fall more.
Post-Issue Market Price Behavior
After the rights issue, there are two primary reasons why the market price might decrease further:
- Increased Share Count: With the increase in shares from 10 million to approximately 12.22 million, the earnings per share (EPS) will dilute unless the new capital leads to a proportionate increase in profits. If ElectroCell’s annual earnings remain unchanged, the EPS will drop from INR 50 to a lower figure, reflecting the higher share count, which can lead to a decline in the share price.
- Discounted Issue Price: Since the new shares are issued at a discount, the market will factor this into the company’s valuation. This discount can pull the overall market price of the shares down as new investors have been able to purchase at INR 450, setting a precedent for what investors are willing to pay.
Hypothetical Price Movements
Before the rights issue, ElectroCell’s share price is INR 500. After the announcement, let’s say the price drops by 5% due to market uncertainty, resulting in a new share price of INR 475.
Post rights issue, the market adjusts to the dilution effect. If the market perceives the issue as neutral and the company’s future earnings capacity as unchanged, the theoretical ex-rights price (TERP) can be calculated as:
TERP = [(Old shares × Old price) + (New shares × Issue price)] / Total shares post-issue
TERP = [(10 million × INR 500) + (2.22 million × INR 450)] / 12.22 million
The theoretical ex-rights price (TERP) after the rights issue would be approximately INR 490.91.
This is the price at which the market might stabilize in the short term, reflecting the dilutive effect of the new shares and the discounted issue price. However, the actual market price could deviate from this theoretical price based on investor sentiment, the perceived success of the new technology, and broader market conditions.
If ElectroCell Technologies can convince the market of the potential of their new battery technology, and if this technology leads to increased profits, the share price might recover and even exceed the pre-rights issue price in the long term. On the other hand, if the market remains skeptical, or if the new technology fails to meet expectations, the share price could remain depressed or fall further.
Cum Rights & Ex Rights
In the context of rights issues, there are two important terms that investors and companies like ElectroCell Technologies must be familiar with: “Cum Rights” and “Ex Rights.” These terms relate to the timing of the rights issue and the entitlement to the rights.
Cum Rights
When shares are said to be “Cum Rights” (cumulative rights), it means that the shares are currently trading with the right to participate in the forthcoming rights issue included. If you purchase shares while they are Cum Rights, you are entitled to participate in the rights issue. The share price typically reflects the value of the rights due to be issued.
In the case of ElectroCell Technologies, if they are trading at INR 500 per share Cum Rights, anyone buying the shares at that price would be entitled to subscribe to the new shares at INR 450 each as part of the rights issue.
Ex Rights
After the rights issue is announced and the shares go “Ex Rights,” it means they are trading without the entitlement to subscribe to the rights issue. If you buy shares Ex Rights, you do not have the right to buy additional shares at the issue price. The share price usually falls when the shares go Ex Rights, as new buyers are not getting the benefit of the rights issue.
For ElectroCell Technologies, once the shares go Ex Rights, new purchasers of the stock would not be entitled to the rights issue at INR 450. The market price would adjust to reflect this, which is what leads to the theoretical ex-rights price (TERP) calculation we previously discussed.
Conclusion
For an EV battery business, a rights issue can be an excellent strategy for raising capital. It not only preserves the equity of existing shareholders but also ensures that the company has the necessary funds to invest in new technologies and expand production capabilities. The decision to opt for a rights issue reflects a forward-thinking approach that could power the future of sustainable transportation.
