How investors can choose between the four options they have regarding the M&S rights issue

Russ Mould
29 May 2019

“Last week’s underwhelming set of full-year results and the possibility that next week’s reshuffle will relegate the company from the FTSE 100 for the first time ever means that Marks & Spencer will be hoping that its proposed £600 million rights issue goes as smoothly as possible,” says Russ Mould, AJ Bell investment director. “Investors now have four options available to them as they assess whether M&S’ strategy to raise the money (and cut its dividend) so it can buy half of Ocado’s food delivery business in an attempt to revive growth in its food and online offerings is the right one or not.

“Shareholders can either:

•        Buy some or all of their allocated stock, which would be one new share priced at 185p for every five that they already own

•        Sell all of their rights which began trading on the London Stock Exchange today 

•        Sell some of their rights and use the cash to buy some of the new shares

•        Do nothing at all.

A detailed explanation of these four options is provided below.

“Which is the right path to take will depend upon both the investor’s view of M&S strategy and its turnaround plan, as well as their personal financial circumstances. 

“They may not have enough ready cash to hand and may be reluctant to sell other holdings to raise the funds, for example. And anyone who is becoming tired of the seemingly never-ending stream of exceptional charges and promises of better times ahead may wonder whether they are throwing good money after bad, especially as Ocado has yet to consistently turn a profit itself from food delivery. 

“Equally, those long-suffering shareholders who have cash to hand may feel it is worth giving the management team the chance to prove the value of the latest strategic initiatives.”

Take up the rights

M&S is offering investors the chance to support the deal with Ocado by giving them the chance to buy one new share for every five their already own (hence the term “one-for-five rights issue”) at the heavily discounted price of 185p. That compares to the 271p price at which the shares closed on the night before the announcement of the full-year results and the terms of the capital raising.

Anyone who owns 1,000 shares in M&S would therefore have the option to buy 200 more at a total cost of £370.

Sell all of the rights

The rights associated with the new shares offered in a rights issue can be traded and have a value all of their own. These are known as nil-paid rights or nil-paid shares and they began trading in their own right today on the London Stock Exchange.

Shareholders in M&S can choose to sell their rights to someone else and raise some cash and do so without having to sell any of their existing holding. This would probably have to be done over the telephone rather than online.

The first thing to do is to work out the theoretical ex-rights price, or TERP. This is calculated by adding together the value of the investor’s existing holding, the value of their new shares (assuming they take them all) and then dividing by the total number of shares held after the capital raising.

In this instance, M&S’ shares closed at 271p on the day before the announcement of the rights issue and the new issue price is 185p. This example assumes the investor owns 1,000 shares.

 

Price

Value

Number of old shares

1,000

271p

£2,710

 

 

 

Number of new shares (1-for-5)

200

185p

£370

 

 

 

Total new shareholding

1,200

 

£3,080

 

 

 

Theoretical ex-rights price (£3,080 divided by 1,200)

256.7p

The value of the nil-paid rights is the difference between the ex-rights price of 256.7p and the subscription price of 185p – or 71.7p.

In this example, any investor who did not wish to entrust any more cash to M&S’ management team could sell their rights to 200 new shares and receive £143.40 in cash.

That would help an investor to recoup all of the value lost on their investment. Had the shares simply stayed at the 256.7p TERP the initial book loss would have been 14.3p per share (271p minus 256.7p) or £143.40 on the holding of £1,000.

However, M&S shares now trade at 236p. This is because the share price will still be subject to the ebb and flow and buying and selling across the wider market.

Also note that any decision not to take up the rights means the investor will suffer dilution in their holding. 

Before the rights issue, the investor held 1,000 shares out of 1,625 million. Afterwards they will own 1,000 shares out of 1,950 million so their percentage stake will have dropped by a fifth (from 0.000062% to 0.00052%). This means they will be entitled to a fifth less of their share of M&S cash flow and dividends in percentage terms (and that is before the dividend cut), which is one way of showing why dilution can be the long-term enemy of the patient portfolio builder.

Sell some of the rights to buy some new shares

Another option is to provide some support to the planned rights issue and purchase of a stake in the Ocado food delivery business by selling some rights to cover the cost of buying some new shares. 

In this case the investors would sell a sufficient number of nil-paid rights in order to take up some new shares. 

This would mean the investor can take up some rights and reduce the dilution of their stake without having to dip into their cash holdings or sell other portfolio positions to do so.

In this example, an investor who wishes to buy some shares but contribute no further net cash could sell 145 of their rights at 71.7p (to raise £104) and buy 55 new shares at 185p (at a cost of £102), to take their total holding to 1,055 shares.

Do nothing

A shareholder in M&S could also let their rights lapse. The risk here is that the nil-paid rights will be worthless upon expiry, if the M&S share price goes below the 185p rights issue price.

If they are still trading above that 185p mark, then the investor could receive a cash payment per nil-paid rights. That payment would be equal to the M&S share price minus the offer price. At the moment that would be the equivalent of 51p a share (236p minus 185p) so the investor could receive £510, although their percentage stake in the company would then be diluted down by a fifth.

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