At the core of the pricing lies the deferred payment plan for investors subscribing to the offer.
Have you heard of "time value of money"? Well, if you understand that concept, you’ll understand how the rights entitlement for Reliance Industries’ shares should be valued.
Simply put, money in hand today is worth more than money 12 months or 18 months later. Why? Because you can earn interest or returns by deploying the money elsewhere.
Therefore, in the case of the Reliance Industries’ rights offer, what you need to factor in is the opportunity cost of money—the opportunity to earn returns till you need to pay the first and second calls of 25 percent and 50 percent, respectively, in May and November next year.
That spells 12 months of returns on Rs 314.25 (25 percent to be paid in May 2021) and 18 months of returns on Rs 628.50 (50% to be paid in November 2021).
What could these returns be? Well, that depends on where you are deploying the money—could be as low as 7.5% on low-risk fixed income, and even 20%-plus if you are actively investing in riskier asset classes like equities or commodities or bullion.
A computation of the possible value of the rights entitlement would, therefore, be derived from a sum of such returns and the difference in the share price of Reliance Industries (Rs 1408 / share at yesterday’s close) and the offer price of Rs 1257—which stands at Rs 151 per share.
The table below provides the indicative math.
|RIL RIGHTS ISSUE - ENTITLEMENT VALUE|
|On App||1st Call||2nd Call||Total|
|Payment (How much?)||25%||25%||50%|
|When?||Now||May 2021 (+12 mths)||Nov 2021 (+18 mths)|
|Present Value||On App||1st Call||2nd Call||Effective Cost|
|Discount Rate - 7.5%||314.25||292.33||563.89||1170.46|
|Discount Rate - 10%||314.25||285.68||544.77||1144.71|
|Discount Rate - 15%||314.25||273.26||509.63||1097.15|
|Discount Rate - 20%||314.25||261.88||414.42||990.55|
|Effective Gain vs CMP||CMP||Gain If 100% on Application||Effective VoR (Rs)|
|Discount Rate - 7.5%||1408||151||237.54|
|Discount Rate - 10%||1408||151||263.29|
|Discount Rate - 15%||1408||151||310.85|
Note: VoR = Value of Rights Issue; Discount Rate implies the rate-of-return on funds deployed elsewhere for the period.
But what should be the price you should pay to buy the entitlement? Clearly the value differential between the current market price of the stock and the benefit from deferred payment of 75% of the offer money could vary widely—as indicated above from Rs 237 to Rs 417 per share, depending on your opportunity cost. And both the buyer and seller would like a slice of this.
So logically, the entitlement should trade at above the mere price differential of Rs 151 per share. Where it settles would depend on how much premium sellers—the finite lot—can command for the right to subscribe.
What will also play a role is the expectation of price trajectory of the Reliance Industries share.
If your stance is bullish and you are looking at a price higher than the current one in 18 months, this is like a long-term call option (the right to own a fully paid-up share at Rs 1275 in 18 months). And with just 25% payment on application, you may be willing to offer a high premium.
On the other hand, if your outlook is negative, you will likely ask for a discount to the price difference.
At what price the rights entitlement final settles is a tough call, like in any market, but given the price differential and the time value of money, some premium seems definitely in order.
First Published: IST