Anatomy Of A Rights Offering

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Includes: FLL
by: Thomas Rice

By Roger Otting

Capturing additional profits by taking advantage of rights offerings

Rights offerings, although not a mainstay of microcap investing, do occasionally crop up in Bowser portfolios. Despite offerings often being misunderstood by novice investors, Buckaroos can seize the opportunity to lower their average cost per share.

During 2016, a rights offering for Full House Resorts (NYSEMKT:FLL) provided an instructive example of how a rights offering might be analyzed to benefit subscribers.

The Offer

Full House Resorts issued non-transferable subscription rights to purchase .2022 new shares of FLL for each share of common stock owned for the bargain price of $1.30 per share. The subscription rights were exercisable for up to a total of 3,846,154 shares of Full House's common stock.

Additionally, the company issued "over-subscription" rights, allowing rights holders to purchase additional shares if not all of the other shareholders exercised their basic rights. Non-transferrable rights have no market value. The rights were granted to shareholders of record as of the close of business on August 25, 2016. The final date that rights could be exercised was October 28, 2016.

The Analysis

On August 25, 2016, shares closed at $1.84, with 19,018,000 shares outstanding, giving Full House a market capitalization of approximately $35,000,000. The proceeds to the company from this offering, if all the rights are exercised, is $5,000,000 (3,846,154 shares multiplied by the offering price of $1.30).

When the rights are exercised, the proceeds received from shareholders directly add to the value of the company. Assuming the company is fairly valued before the rights offering, the market capitalization after the offering would rise to $40,000,000 dollars. With the additional shares issued, the new share count will be 22,864,154 shares (the sum of the prior shares outstanding and the 3,846,154 shares from the offering). Dividing the new market cap of $40,000,000 by the new share count of 22,864,154 results yields a projected post-rights-exercise price of $1.75 per share.

Each right allows the holder to purchase only .2022 shares. So, it takes about five rights, plus $1.30 per share, to obtain a new share. The new shares, purchased for $1.30 per share, provide investors with a discount in comparison to the projected price of $1.75.

The difference between the projected price and the offering price is $0.45 per share. Because it takes five rights to purchase shares at the bargain price, each right has an intrinsic value of $0.09. For example, an investor owning 500 shares would receive 505 rights, each good for .2022 shares at the bargain price, or enough for about 101 shares.

The Effect

Because the rights offering allows investors to purchase shares at a discount, it will be dilutive to current shareholders. An investor holding 500 shares can expect to see the value of his or her shares diluted by 500 shares multiplied by the value of the rights of $0.09, or $45.00.

The exercise of the rights gains $45.45 (the product of 101 shares and the difference in our projection and the offering price of $0.45). However, the original holdings will be depleted in value by almost the same amount.

In order to avoid losing money, the rights must be exercised.

There is a caveat. The rights offering allows for additional participation. To the extent that other shareholders do not exercise their rights, those that did are allowed to purchase additional shares with "over-subscription rights" at the same low purchase price of $1.30 per share.

The Results

Between the aforementioned date of record and the final exercise, the market price ranged from $1.56 per share to $2.03 per share. At no point was the price ever "out of the money" where the analysis did not show that it was profitable to exercise the rights.

Not all rights-holders exercised, and additional shares were sold to those who exercised through the oversubscription option. Subsequent to October 28, 2016, the price varied from $1.60 to $2.49, and closed at $2.45 on February 3, 2017. Shareholders who did not exercise their rights have seen the price rise from $1.84 to $2.45. Shareholders who exercised their rights saw the same price rise, and were also able to obtain a few shares at a bargain price for some additional profits.

The Conclusion

Offerings can provide investors with a unique opportunity to increase their position size and purchase shares at a discounted price. However, uninformed investors could potentially see the value of their shares decrease due to dilution. These offerings have a short-term negative effect but directly add value to the company and can be very beneficial for subscribers who take advantage of the opportunity at hand.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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