Jaks Worth Only 40sen?

On 22 May 2020, the share price of Jaks closed at RM1.03. 

Then it announced a corporate exercise of rights issue of shares (4 existing shares : 2 rights shares) and warrants (2 rights shares : 1 warrant).

The next trading day, its share price fell 15% to close at 87.5sen. 

I guess this type of reaction occurs to most cash calls as investors might be worry of the potential dilutive effect.

It might be the case in Jaks, and might also be possibly due the lowish illustrative price of Jaks rights shares at 40sen per share.

Public Bank quickly downgraded its target price substantially from RM1.13 to RM0.77 on "potential dilution of the cash call".

Obviously it will be a massive 50% increase in outstanding shares immediately, and potentially up to 75% when all the new warrants are converted into shares. EPS will be adjusted lower by 33% & 43% respectively. 

However, is there any dilution effect on shareholders' holding?

If I cut a large pizza into 4 equal pieces and I get one piece, I have 25% share.

Then there is a second pizza which is half the size of the first pizza up for sale. It is cut into 4 equal pieces as well and I'm eligible to buy one piece or 25% of it. Even though this piece is 50% smaller than the first one, it's still a 25% share for me.

Then I am given a voucher to buy 25% of a new pizza which is only a quarter of the size of the first large pizza. If I use the voucher to buy it, my overall share in these 3 pizzas is still 25%.

There are more pizzas now, but I still have 25% of all of them. So, there is no worry about the dilution effect for existing shareholders after the rights issue. 

Is it worth to buy those extra pizzas? If the pizzas are tasty and value for money, why not? If the pizzas taste terrible and are expensive, why should I buy more?

Even if you don't want to buy those extra pizzas, you can sell your rights and vouchers to get cash. You lose your shares but gain cash. 

The rights shares price is proposed at 40sen as illustrative purpose. The actual price will only be decided according to the latest share price when the final announcement is made. 

This 40sen does not mean that the true or expected value of Jaks share price is 40sen.

When the announcement was made on 22 May, the closing share price of Jaks was RM1.03, while the 5-day VWAMP (Volume Weighted Average Market Price) was RM1.07.

The price of rights share is usually determined by giving a discount to the TERP (Theoretical Ex-Rights Price).

TERP as its name suggests, is the theoretical adjusted share price after the rights issues are exercised. It is calculated as:

market value before rights issue + cash raised from rights issue

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            total numbers of shares after rights issue

For Jaks case, the share price used to determine the market value is the 5-day VWAMP (RM1.07), while the outstanding shares that day was 651.1mil

market cap before rights issue =  RM696.7mil (651.1 x 1.07)

cash raised from rights issue =  RM130mil (325 x 0.40)

total shares after rights issue =  976.1mil (651.1 + 325)

TERP = RM0.85

The proposed rights share of 40sec each is a 52.94% discount to the TERP of 85sen.

The management mentions that rights share price will be at least 50% discount to the TERP. So it might change if the share price move substantially up or down from RM1.07 when the price fixing date arrives. 

I don't have a lot of experience regarding rights issue but I think it is common for such a huge "discount" given to the rights shares, even though in reality share price will also be adjusted accordingly so that shareholders do not get anything at "discount" or "free".

In other words, you may think that you get the rights shares cheap at 40sen and earn big from it immediately. Actually it's not, share price after the rights issue will be adjusted lower and you have nothing to gain or lose.

I have subscribed to Inari's rights issue with warrant before in year 2014. When the cash call was first announced in early July 2014, Inari's share price stood slightly above RM3, with 5-day VWAMP of RM3.09.

It was a 8:1 rights share + warrant. TERP was RM2.91 and the illustrative rights share price was just RM1.50, which was also around 50% discount to TERP.

Did Inari's share price fell to RM1.50? Of course no, not even close.

The final rights share price was fixed when the market share price was around RM3, so the rights share price was the same to the proposed figure of RM1.50.

For Dayang's rights issue in 2019, initially its proposed rights share price was at RM0.80, which was a 33% discount to TERP of RM1.14 and the 5-day VWAMP was RM1.23.

Dayang's share price initially dropped to around 90sen in respond to the cash call but later went up higher and higher to over RM2 before the rights issue ex-ed.

The final rights share price was fixed at RM0.92, with around 50% discount to TERP of RM1.83, while 5-day VWAMP was at RM1.92 which was 56% higher compared to the time when announcement was first made.

These show that rights shares offered at 50% discount to TERP is not uncommon.

Rights issues can be good or bad. If it is for good reasons, share price will likely go up. If not, share price will inevitably drop.

For Jaks, whether it's good or bad, it's up to you to decide.