Bank of Kigali Group PLC is offering over 200 million new ordinary shares to its existing shareholders through a rights issue. A rights issue, a situation where new shares of a company are sold to existing shareholders on a pro-rata basis to the shares owned at a discount compared to the market share price, is one of the equity financing options available for companies. The other alternatives are through public issue and placement. By the time of writing this article, BK’s shares were trading at Rwf289 on the Rwanda Stock Exchange. Now, the company is offering new shares at Rwf270, which translates into a discount of 6.57 per cent. Existing shareholders are allowed to subscribe 1 share for every 3 owned shares. The central question is, what is the impact of the rights issue on shareholders’ wealth? In order to illustrate this, let’s use the example of Mr. X. Mr. X, who currently owns 1,200,000 shares is entitled to buy 400,000 additional shares. His stake in BK is currently worth Rwf346.8 million. There are three options available to Mr. X: Option A: Subscribe for the new shares and pay Rwf108 million to BK and keep the shares. He will thus own 1,600,000 shares. Option B: Subscribe for the new share, pay Rwf108 million to BK and sell all or part of the rights issue. Option C: Do nothing and let the offer lapse. The Theoretical Ex-rights Price (TERP) is the proxy of the market share price immediately after the rights issue. The principle behind it is that if all shares are subscribed, the market share price will immediately fall to the new price, TERP. This is how it works: Three shares at Rwf289 each are worth Rwf867 while 1 additional share at Rwf270 is worth Rwf270. After the rights issue, there would be 4 shares worth Rwf1, 137, meaning each share would be worth Rwf284.25. The value of rights issue is therefore Rwf14.25. Theoretically, BK shares would sell at Rwf284.25 immediately after the rights issue (and for how long?). Coming back to our initial question, what will happen to Mr. X? Option A:If Mr. X decides to take the rights and buy 400,000 shares, his worth will now be Rwf454.8 million after paying Rwf108 Million, which means that his net worth remained unchanged at Rwf346.8 as it was before the rights issue. Option B:Mr. X decides to take the rights and sell them: He pays Rwf108 million to buy 400,000 shares and sell them to get Rwf113.7 million, making Rwf5.7 million (assuming no commissions and taxes). However, the remaining shares are now worth Rwf341.1 million compared to his initial value of Rwf346.8 million, a reduction of Rwf5.7. Thus, the gain from buying and selling of rights issue will net off the loss suffered in the reduction of the share price, leaving his net worth unaffected (he may loose on commissions and taxes!). Option C:Mr. X ignores the offer. He remains with 1,200,000 shares but is now worth Rwf341.1 million, which is Rwf5.7 million less than his net worth before the rights issue. In summary, responding to BK’s call to subscribe for the rights issue is the appropriate decision for existing shareholders. An investor who lets the offer lapse is likely to experience a fall in his stake in the company, after the rights issue, potentially losing approximately Rwf14.25 per share. This is at least what the finance literature has taught us. Of course the economics taught us the “caeteris paribus”, or other factors remaining constant. Other factors may influence the direction for the rights issue; such as public perception on the Rwanda economic outlook, saving levels, alternative investment opportunities, expected performance of the Bank, announced cross-listing of BK shares on the Nairobi Stock Exchange and more importantly, what the Bank plans to use the Rwf60 billion that it will be raised through the rights issue. The rights issue itself doesn’t create value, but investing in positive NPVs does. So far, BK’s performance has been encouraging. Since 2010, its net income grew at a compound annual growth rate of 21.5 per cent from Rwf18.7 billion in 2010 to Rwf73.1 billion in 2017. Its profitability has improved remarkably, from a net profit of Rwf6.1 billion 2010 to Rwf23.24 billion in 2017. Its total assets grew on average by 15.9 per cent per year, from Rwf197.67 billion in 2010 to Rwf727.16 billion in 2017. The earning per share grew tremendously, and almost tripled from 12.34 in 2010 to 34.67 in 2017. Let’s stay tuned on RSE to compare the academics and the reality as fundamental analysis can only predict the future, but no one has ever seen that future, not even clergymen! The writer is a member of the Institute of Certified Public Accountants of Rwanda (iCPAR).
