IanTHughes wrote:I have not investigated the reason for the Rights Issue but I do agree that, if capital is being raised for a profitable venture then no, it is not on its own a red flag for an HYP. And it certainly is not a sign for a current holder to ditch the shares. No, if I was to go back in time and look at GFRD with a view to a purchase, the dividend decrease would have warned me off but, without that cut, the Rights Issue would have been further investigated before making a decision.
I think it worth adding something that I'm pretty sure you're aware of and understand, but that some readers may well not. It's that
almost all rights issues by dividend-paying shares result in an actual decrease in the dividend paid per share. The reason for that is that if a shareholder doesn't take up their rights (which is effectively buying shares, for a right plus the subscription price each) or sell their rights, then the company effectively sells their rights for them shortly after they lapse at the end of the rights issue (*). Those rights were created in the first place at the start of the rights issue, when they were split off from the shares as they went ex-rights, and that split effectively transferred part of the value of the pre-rights issue shares to the rights: if you look at what happens overnight as the shares go ex-rights, you'll find that the share price suffers an ex-rights drop, as a result of which the value of the shareholding falls by about the value of the newly-created holding of rights, so that the overall value of the portfolio doesn't change any more than normal overnight share price fluctuations would change it.
So looking at the overall effect of the rights issue from start to finish, on the assumption that the shareholder does no selling or effective buying, it is effectively to take part of the value of the original shareholding, package it up temporarily as rights, and then sell it. Or more briefly, the company is effectively selling part of the shareholder's original shareholding on the shareholder's behalf, whether the shareholder wants them to or not. This is very similar to what happens if the company pays a special dividend (or more rarely, a capital distribution) to the shareholder and simultaneously consolidates its shares, when the shareholder is down a certain number of shares due to the consolidation and up the amount of the special dividend in cash - i.e. in effect (and for almost all practical purposes other than taxation), a forced sale of that number of shares for that amount of cash. Not exactly the same situation - for the special dividend + share consolidation, the part effectively sold is a fraction of the number of shares, while for the rights issue, it's a fraction of the value of each share - but that's basically a cosmetic difference on the fact that part of the shareholding has effectively been sold.
The general rule about corporate actions and dividend-per-share figures is that whenever possible, the company adjusts the previous year's dividend-per-share figure to compensate for any changes its corporate actions cause to the number of shares held by a shareholder who neither bought nor sold during the year, basically to make the reported dividend percentage increase reflect the change to the dividend income received by such a shareholder. For example, a share that does a 2-for-1 share split adjusts its prior-year dividend-per-share figure by halving it, because a shareholder receiving that halved dividend on their now-doubled number of shares would receive the same amount of dividend income from their shareholding as they did the previous year. The company uses that adjusted prior-year dividend-per-share figure as their baseline dividend per share going forward.
They cannot do that in either of the cases I give above where the company has effectively sold part of every shareholder's holding on the shareholder's behalf, because that is counted as the shareholder having sold for this purpose. So when the company has done such a corporate action, there is no such thing as a shareholder who has neither bought nor sold. The next best thing is to do the calculation for a shareholder who has reversed that sale as far as possible by using the proceeds they've received to buy back the part of their shareholding that was effectively sold, or at least as much of it as it is reasonably realistic to assume that a shareholder might be able to buy back in practice. Even that isn't something the company can do entirely accurately, due to the varying effects of share price fluctuations on different shareholders, but they can generally produce a reasonably close approximation by assuming a particular reasonably realistic price from around the time of the corporate action. So they do that, and they also assume no trading charges because the shareholder has the opportunity to effectively buy free of trading charges by taking up some of their rights, and they count the change in the number of shares due to the assumed purchase as one caused by the corporate action.
In the case of a special dividend + share consolidation, the consolidation ratio is normally (though not quite always!) chosen so that the amount of special dividend received by a shareholder is close to the market value of the shares lost to the consolidation - i.e. so that the effective price of the effective sale is close to the current market price of the shares. That means that the company can not-too-unrealistically assume that the shareholder can make a purchase that buys the number of shares lost to the consolidation with the special dividend. That means that counting both the effective sale and the assumed purchase, there is no net change to the shareholder's number of shares, and the result is that there is normally no prior-year dividend-per-share adjustment for a share consolidation that accompanies a special dividend or capital distribution, even though there is one for an unaccompanied share consolidation.
In the case of a rights issue, the splitting-off of the rights as the shareholding goes ex-rights does not alter the number of shares held, and the assumed purchase made with the lapsed-rights payment (**) increases the number of shares held. So the total effect of the rights issue is to increase the number of shares held by the shareholder they assume for the adjustment, just as a share split or bonus issue would. And so they do make an adjustment downwards to the prior-year dividend as they would for those corporate actions, dividing it by the same ratio as the number of shares is assumed to be multiplied by. That adjustment is generally called adjusting for the "bonus element" of the rights issue in company reports and results announcements, I think because it's most closely analogous to the number-of-shares increase caused by a bonus issue (***).
Anyway, the adjustment to the prior-year dividend-per-share figure is usually greater than the dividend increase (if any) that the company intends to pay to the shareholder they're assuming - i.e. one who does no buying or selling other than buying to cancel out the effects of effective sales compulsorily made by the company on the shareholder's behalf. The net result is that when there is both a corporate action that does an effective sale and such a dividend increase, the unadjusted dividend usually drops from year to year - and of course, when there is such a corporate action and no intended dividend increase, the unadjusted dividend always drops from year to year. Hence my assertion at the top of this reply that almost all rights issues by dividend-paying shares result in an actual decrease in the dividend paid per share.
So basically, there are two ways to look at the what-happens-to-the-dividend issue for rights issues. If one literally does nothing in response to rights issues, then one's number of shares doesn't change and so the actual dividend-per-share change from year to year indicates what happens to the dividend income one receives from the holding, which will almost always be that it falls. But one usually receives some compensation for the loss of income in the form of a lapsed-rights payment, and one can generally make more certain of that payment by selling the rights as soon as possible, because that makes the amount you receive less subject to a less long period of share price fluctuations (though note that those fluctuations can generally just about as easily be to your advantage as to your disadvantage).
Alternatively, you reinvest the lapsed-rights payment (or proceeds from an earlier sale of rights) in the company's shares, and then the dividend increases or decreases reported in the company's reports and results announcements tell you roughly what happens to your dividend income. Or as a slight variant, you reinvest them in some other holding you prefer, in which case you've basically shifted some of the holding's dividend income to being generated by another holding, presumably because you think it will improve the overall portfolio dividend income, by making it bigger, safer or both.
I was going to end this post by applying the above to Galliford Try, but my attempt to do so ran into something I wasn't expecting in Galliford Try's reports, and what I wanted to say rambled on a bit. So I've cut that bit out of this post and will post it next.
(*) "Effectively" because it's not actually possible to sell rights at that stage, there no longer being any market for them. So what the company does instead is normally that it sells the shares the rights could have been taken up for, takes the subscription price out of the proceeds (and selling costs come out of them as well, as for any sale) and distributes the remaining proceeds to the owners of the lapsed rights as a lapsed-rights payment. This produces a good approximation to what the rights could have been sold for, had there still been a market for them at that stage. Much less normally, the share price has fallen to the point where nothing or less than nothing would be left after deducting the subscription price and selling costs from the proceeds of selling the shares: in that case, the company requires the underwriter to meet its obligation to pay the subscription price for the shares if it can't be raised either from shareholder subscriptions (in the normal case that the rights issue is underwritten, otherwise the company simply fails to raise the capital it wants) and doesn't pay any lapsed-rights payment, and not receiving anything is again a good approximation to what the rights would have been worth if there had still been a market for them.
(**) There is the issue of what price to assume the purchase happens at. In the case of a special dividend + share consolidation, it's basically when the consolidation ratio is set, while in the case of a rights issue, it's from about the time that the shares go ex-rights (I'm not certain about the exact time and price used, but it's then or about then). In each case, the actual cash payment will probably be a few weeks later. This isn't a significant problem if the share price doesn't move significantly in those few weeks, nor is it one for shareholders who can borrow money short-term reasonably easily and cheaply. The latter includes just about all major shareholders, and so the company assumes that shareholders can make the assumed purchase at very close to the price it assumes, essentially at no more than the trading costs the company is regarding as negligible anyway. In addition, in the case of a rights issue, one can get access to the cash value of the rights as early as shortly after the shares go ex-rights if one wants, at the cost of an extra broker commission, by selling the rights. So it is generally feasible for all but very small shareholders (for whom that extra commission greatly affects the effective sale price) to make something close to the purchase the company assumes if they want, though they will have to stir themselves into more active trading than strictly necessary to do so!
(***) Though I would note that the points on which it is more closely analogous to a bonus issue than to a share split are technicalities that are almost always completely irrelevant in practice to shareholders, such as that share splits reduce the nominal value of a share while bonus issues and rights issues don't affect it. And that IMHO "bonus element of the rights issue" and "bonus issue" are rather tactless terminology, because shareholders don't get any financial bonus out of either: a shareholder in a company that does a 1-for-1 bonus issue ends up with twice as many shares as they started, but the share price roughly halves and so they see no financial gain or loss other than that caused by normal market fluctuations, while a shareholder in a company that does a rights issue and does nothing whatsoever about it ends up with the same number of shares as they started with plus a lapsed-rights cash payment, but with a share price that has dropped by roughly enough to cause their holding's market value to drop by the same amount as that cash payment. So they also see no financial gain or loss other than that caused by normal market fluctuations, and they'll very reasonably regard the lapsed-rights payment as compensation for the drop in their holding's value rather than as a bonus... But tactless or not, "bonus element of the rights issue" and "bonus issue" are very well-established terminology, so we're probably stuck with them!
Gengulphus