FOR BEGINNERS: NO. 4 How shares are issued

Press, 11 April 1984, Page 34

FOR BEGINNERS: NO. 4 How shares are issued

By

ADRIAN BROKKING

Shares may be made available to the public, “issued,” in a number of ways. The most common way is for the company to issue the shares itself. In New Zealand this method is often partially combined with what in Great Britain is called an “offer for sale.” In an offer for sale the shares are allotted to an issuing house (in New Zealand usually a merchant bank or a sharebroking firm) which in turn offers them to the public. When a member of the public takes up shares the issuing house renounces its allotment for that parcel of shares. In New Zealand the issuing house often is allotted part of the issue which is then said to have been taken firm, and disposed of as that house sees fit. Often the merchant bank or sharebroker acts as underwriter, that is agrees to take all. the shares the public does not subscribe. If the issuing house is a sharebroking firm, it often will take part of the issue “firm” but give other sharebrokers throughout New Zealand a firm allotment of shares which they in turn distribute among their valued clients. However, New Zealand companies usually insist that there should be a large pool of shares available to the public at large, to ensure a wide spread of shareholdings. In such a case, the public can apply directly to the organising house for shares from the “public pool.” If there are more applications than shares available, applications are usually sealed down proportionately. In any case, a prospectus must be issued, containing a

large amount of information required by law and the rules of the stock exchange. Space does not allow to describe here this mass of information. Its purpose is to make sure that as far as is humanly possible, the potential investor has sufficient information to judge the merits of the company and its objects. Relevant extracts of many prospectuses are published in the newspapers and commented on in the financial pages. Another method of issuing shares is by a placement. This saves the cost of an offer for sale, and is often done when the new issue is fairly small. In New Zealand these placements are Usually private placements, and the shares are allotted to a limited number of large investors, such as the institutions (mostly life insurance officess). When an existing company requires more funds, it goes to its shareholders to provide more capital, by making a rights issue. This is made in proportion usually for less than the market price of the existing shares. Say a company has a paid-up capital of $4 million, and it wants to raise a further $1 million to finance expansion. The required amount is one quarter of the existing capital, so the issue would be made in the proportion of one for four — that is the shareholder has the right to subscribe for one share for every four he already holds. This right can usually be traded. If the shares are selling at 300 c on the stock exchanges, and the company sets lj|e price of the new

shares at 200 c, the right would acquire a value, in this case 80c. The four old shares plus the new share average out at 280 c each, and 200 c must be paid to take up the new share. A quick check on this calculation is to deduct the value of the right just worked out from the value of four shares and then again dividing by four. The answer should be equal to the average of 280 c found in the previous paragraph. Also, the amount by which the shares “average down” (four times 20c) should equal the value of the right. The value of the right is a theoretical one, because the market usually reacts to the announcement, either favourably or not, by immediately varying the share price, and keeps on doing that until the rights are exercised. The buyers and sellers — the sharemarket — immediatley make adjustments to the share price to reflect the value of the entitlement to the new issue. With a rights issue the shareholder has four choices: to take up the new shares, to sell the rights, to buy more rights in the open market, or to buy more “head” shares. Many successful companies give a bonus of new shares to their existing shareholders from time totime. Overseas this is called a scrip issue. Scrip issue is a better name, because it really is not a bonus. The shareholder is only given what he already owns. A shareholder has a proportionate share in the assets of the company, and also the liabilities of the company. As assets are usually larger than liabilities, the company has a net wlrth,

the “shareholders funds,” which shows up in the balance sheet as capital and reserves. If the capital is $4,000,000 in 100 c shares, and the reserves $2,000,000, the “net aset backing” of the shares is 150 c. If a shareholder has 400 shares, his stake in the company is worth $6OO. A scrip issue of one share for every five held, would give him 480 shares, but his stake in the company is unchanged, because the net worth has not changed. The 480 shares have a net asset backing of $6OO, that is 125 c each. The sharemarket recognises this by reducing the market price after the bonus issue to, in our case, five-sixths of the previous market value.