All about REIT - Rights Issue Part 1: Terms and Definition

REITs normally raise funds for its acquisitions by debts. However, there are certain circumstances that will restrict a REIT from borrowing further. One situation will be the 35% (60% with corporate rating) limit on its gearing (see All About REIT - The Basics Part 4: Gearing Limit) has been reached, such that its debt level cannot be further increased. Sometimes the REIT may be trying to refinance an existing loan, and the refinancing terms may not be favourable and higher interest cost may be incurred. This is especially so during the period of credit crunch after the collapse of Lehman in 2008. Under these circumstances, the REIT may have to raise new funds by equity instead. Rights issue is one way in which a REIT can raise funds by equity. A straight forward description of rights issue is as follows:

The company issues new shares to existing shareholders. Shareholders can take up the new share at a price, or can give up the entitlement.

The above is a very simplistic view of the rights issue, but it covers the main idea. In an actual situation, the company issues rights to the existing shareholders first. These rights are actually entitlements to subscribe to the new shares to be issued. The rights may have a market value and may be traded within a specific window period. The owners of the rights can choose to subscribe to the new shares or give up their entitlement.

In 2009, quite a number of REITs have gone on the path of rights issue to raise funds and strengthen their balance sheets, examples being A-REIT, CapitaMall Trust, CapitaCommercial Trust, Frasers Commercial Trust, K-Reit, Fortune Reit, AIMSAMPI Reit, and Starhill Global Reit.

Following are some terms and information related to rights issues:

Rights to Share Ratio
The number of rights issued per existing share. Example a 1 for 1 rights issue means each existing unit will be issued with one right, which in turn entitles it to one new share. Following the issue of the new shares, the total outstanding shares will be doubled in this case. Another example is FCOT's 3 for 1 rights issue in 2009. 3 new shares has been issued for each existing share, thereby increasing the total outstanding shares by 4 times.

Renounceable Rights
Usually we will see this term being mentioned in the circulars about the rights issue. Renounceable rights means that the rights are transferable and can be traded off if the unit holder does not wish to subscribe to the new shares. The rights can also be non-renounceable, meaning it is non transferable and hence cannot be traded. Most, if not all the rights issue of the REITs in 2009 involved renounceable rights.

Trading of Rights
This applies to the renounceable rights. Usually there will be a window period of 1 to 2 weeks for the rights to be traded in the stock exchange. A temporary counter for the rights will be created for this purpose. Unit holders who do not wish to subscribe to the new shares can sell of their rights for a value determined by the market. After this window period, the unit holder can only choose to subscribe to the new shares, or give up the entitlement.

Subscription price of the new share
The price the owner of the rights need to pay to subscribe for each new share. Normally this will be at a discount to the last traded price of the Reit before the announcement of the rights issue, or to the average share price of the last few days. In the earlier part of 2009 when market is still uncertain, the discount given was rather large, probably to encourage more unit holders to take up the new shares.

Excess Rights
More often than not, some may give up the entitlement to the new shares although they hold the rights. These rights then become the excess rights. Those who choose to subscribe to the new shares with the rights they own can also opt to subscribe to new shares with these excess rights. If the number of applications to the excess rights exceeds the available excess rights, some kind of balloting process will kick in. Usually those who have odd lots of the rights will have priority. Example if you have 999 rights, you will have a high chance to get the 1 excess right for you to make up a full lot of new share.

Pro Forma Figures
The Pro Forma Figures is a set of important figures that are usually presented in the circulars about the rights issue. The pro forma figures are estimated values of important financial figures such as yield, gearing, NAV, revenue, net profit, etc, assuming the rights issue has been carried out at an earlier date, usually 1 year or 6 months ago. The past financial figures will be adjusted accordingly to factor in the effect of the rights issue. It will factor in the reduction in interest payment for debts if the funds raised has been used to pay up loans. If the rights issue comes together with proposed acquisitions of new properties, then the increase in distributable income from these new properties will be factored in. Most importantly, the increase in total outstanding shares will be factored in when calculating the figures such as yield and NAV. The pro forma figures is an important set of figures to look at if you want to estimate the diluting effect of the rights issue. The yield may decrease in the short term due to the increase in the share base, but the pro forma figures will give an idea of yield in the middle to long term after factoring in payment of debts and income from new acquisitions. However, do take note that these are estimated figures, and the actual figures may turn out better or worse.

Related Posts

• All about REIT - Rights Issue Part 2: What happens during a Rights Issue
• All about REIT - Net Asset Value (NAV) and Asset Valuation   
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