Yesterday I went on endlessly about a ridiculous speculation I’ve long owned called Coastal Caribbean — CCO on the Boston Exchange (CCO BF is the symbol some quote systems use). I didn’t do so to recommend the stock, which is now a good deal higher than I paid for it. (I’ve been selling, not buying, recently, myself.) And I didn’t do it to brag that it had gone up. (Sure it had jumped from three-eighths to over two bucks a share. But I had first bought it 20 years ago, whereas you kids have gotten used to stocks jumping that much in the first three hours of their going public.)
No, I made you wade through all that so as to have a real life example to describe the joys of oversubscription. But first I have to explain “rights.”
Sometimes, a company you own will issue rights. You will get a notice that, say, for each six shares of Safeguard Scientific you own, you have been issued the right to buy one share of some new company it is spinning off for $5. (That’s an actual example. The rights were perceived as valuable, because Safeguard has a history of spinning off companies at $5 that quickly rise to $20.) Or you’ll get a notice that for each ten shares in a closed-end mutual fund that you own, you are getting the right to buy an additional one for a 5% discount. (That, too, is an actual example — and far less appealing.)
Rights offerings vary greatly. Some are irresistible, some not. And this is reflected in the market value of the rights themselves. If they are perceived as valuable, there will often — not always — be a market for them in the several weeks between the time they’re issued and the deadline for exercising them. You can either sell your rights to someone else, or exercise them. What you should not do, if they have any value, is just let them lapse. But inevitably some people will, either because they didn’t know about the rights offering or understand it, or because it wasn’t worth the effort. (There are those of us who’d spend 20 minutes haggling about a disputed $35 phone bill, but wouldn’t think twice about letting 1,000 rights expire if they were only worth three cents each.)
I’d guess rights often sell for less than their worth, because exercising them requires capital that not everyone can come up with. So some will just let them expire, while others will sell them but not care too much about the price — whatever they get is just a nice little bonus, like a dividend.
On the other side of the transaction, if the stock isn’t widely followed, there may not be a huge demand for the rights, whatever their theoretical value. Say a closed-end fund is selling for $10 and one right allows you to buy a share at $9.50. You might say that right is “worth” 50 cents and 100,000 of them should be worth $50,000 — except that the buyer is going to have to pay commissions to buy the rights, and then is going to have to come up with $950,000 to buy the shares, and then is going to have to pay another commission if he wants to sell those shares and realize his profit — and may have a heck of a time selling 100,000 shares without driving the price down. All of which would explain why a large institution wouldn’t want to scoop up everybody’s rights for 50 cents, even if they’re “worth” that in this example . . . and why, if you go to sell yours, you might get just a few pennies.
Anyway, that’s a little about rights. I guess they fall into two categories, for the most part: those that are really pretty trivial, like the closed-end fund offering I just described (meant mainly to expand the assets of the fund and the management fee of the fund manager); and the ones that are clearly valuable, like the Safeguard Scientific rights for which people have paid upwards of ten bucks each.
Clearly, when you receive rights, it pays to determine just what they’re worth, and — if they do have some value — not allow them to expire without selling or exercising them.
So now you know about rights. Let me tell you specifically about the recent Coastal Caribbean rights offering, because it’s a way to explain “oversubscription.”
Periodically, in order to finance its preposterous lawsuits and the president’s canoe trip, Coastal Caribbean needs to raise some money. Most recently, with the stock trading around 2-1/2 (and its main lawsuit, for the right to drill on its leaseholding actually going pretty well), it issued each of us holders one right for every 5 shares outstanding — so if you owned 1,000 shares, you received 200 rights — and these rights entitled you to buy an additional share for just $1.
On its face, you might conclude that each right was therefore worth $1.50. Certainly the right to “buy” 10 quarters for a dollar bill would fetch pretty close to $1.50 on almost any street corner (especially because we so frequently need quarters for the parking meter or the pay phone — but I digress).
But the first thing to note with Coastal Caribbean is that if the stock was worth $2.50 before the rights were exercised, it should be worth only $2.25 afterwards. Why? Well, look at it this way. Say the entire company had been divided into only 5 shares. (Actually, there were many millions.) Each was worth $2.50, for a total market valuation of $12.50. Now this rights offering, that allows you to buy another share of stock for $1 instead of $2.50, is completed and the only thing about the company’s value that has changed is that it has an extra $1 in cash — the money you paid to buy the new share. So now instead of being worth $12.50 divided among five shares, the company is worth $13.50 divided among six — $2.25 each.
So in that sense the rights were worth $1.25. They let you buy for $1 a share that would be worth $2.25 after you did.
But a right is worth only what someone’s willing to pay for it, and in any event, the stock had begun to fall sharply after the rights offering was announced, to around 1-5/8 — in part, perhaps, because people were telling their brokers, “Well, listen. I’m sure as heck not going to come up with $2,000 to exercise my 2,000 rights. So why don’t you just sell $2,000 worth of the stock now, and then use that money to exercise the rights. In fact, while you’re at it, why not sell $3,000 of the stock now. That’ll give me enough extra to pay tax on my gain and take the kids to Red Lobster.”
That would create selling pressure on the stock, and may be one reason it fell back from $2.50 to $1.625. Which made the rights far less valuable still.
Note that anyone who “just did nothing” would lose out because of “dilution.” When a company issues new shares, all the old shares are diluted. Each one now represents a slightly slimmer slice of the pie. Maybe this should be called “slimming” but it’s called dilution.
Anyway, I didn’t pay any attention to what the rights were trading for, because I knew no one would be dumb enough to pay me enough to make them worth selling (and paying tax on the sale). In fact, far from selling my rights to buy Coastal Caribbean at $1, I should probably have considered buying them — except that, as it turned out, these particular rights were “nontransferable.” Use ‘em or lose ‘em.
What I did do was to instruct my broker to “oversubscribe” for the maximum number of shares allowable. Here’s what that means. Each right allowed you to buy one additional share for $1, for sure, but also to “oversubscribe” for additional shares in case not all the rights were exercised.
In other words, the company wanted to be sure to raise the amount of money they had targeted, at $1 a share. If everybody exercised her rights, they would. But in the real world, some people are inevitably asleep at the switch. They will just let them expire. So in this particular deal, each right-holder could oversubscribe for up to 3 more shares per right. That is, if you had 1,000 rights, you could put in to buy your guaranteed allotment of 1,000 shares at $1 each, plus ask to buy up to 3,000 more. Chances are you wouldn’t get anything remotely like 3,000. But any leftover shares would be parceled out to people like you on a pro-rata basis.
This is a clear case of the rich getting richer, because not everyone can afford to come up with the full oversubscription price (which your broker will require, against the theoretical possibility that you would actually get the full number of shares you oversubscribed for). So lots of people don’t oversubscribe at all, or else oversubscribe for relatively few shares. You, who oversubscribed for the maximum, will get a disproportionate allotment of any such “left over” shares.
Am I making any sense?
It was possible, of course, that by the time the dust settled the stock would be down to 1, or even below. But at $2.50 or so when the rights offering was first announced, and even at $1.625, which is the lowest point it reached, it was unlikely it would plummet all the way to $1 and beyond. So the “oversubscription” aspect of this particular rights offering was about as close to free money as I can recall. I oversubscribed for the maximum and got, to my amazement, 42% of what I asked for. In other words, for each right, I got not just 1 share at $1 each but 1.42 shares at $1 each.
The rights offering expired in early June; the stock bounced back up to 2 5/8 almost immediately; and I was able to sell 10,000 shares for $2.625 that I had gotten for $1. (I just sold some more a few days ago at $2.25.)
- Not all rights offerings are this dramatic by any means, but whenever you get rights you should at least take the time to discover whether the deal is trivial or one you’d be a fool to ignore. Many of the Coastal Caribbean owners, judging from my success with the oversubscription, just didn’t bother to do this.
- When it’s a rights offering designed to be irresistible (either to reward shareholders and/or to be sure people exercise so the company raises the money it needs), consider oversubscribing to the max!
- Remember that if you don’t at least exercise your rights, you will be “diluted” — you’ll own the same number of shares, but a slimmer piece of the pie.
- Remember that if the rights have value and you don’t want to (or can’t afford to) exercise them, you may be able to sell them — but will likely get for them less than they’re worth (and have taxes to pay).
- And remember, finally, that in order to come up with the cash needed to exercise the rights, you can always sell some of your existing shares first (although that may expose you to capital gains tax).
Tomorrow I’ll tell you one more thing about Coast Caribbean I learned in checking out this comment. It shows that the S.E.C., in its efforts to protect us (which I applaud) is not infallible.
Quote of the Day
Capitalism without bankruptcy is like Christianity without hell.~Frank Borman (ex-Eastern CEO)
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