Right to buy Rights?

MTD Walkers PLC, known as KAPI.N000, has announced the dates for the proposed Rights Issue. I reproduce the announcement below:

As per the announcement, the Company is issuing 466 new shares at LKR45 per share for every 1000 shares held by shareholders. (please note that as I write this post KAPI.N000 is trading at LKR62.80 per share). With the proposed rights issue they plan to raise c. LKR2.4 billion and issue c. 53.3 million shares.

So, I asked the question, is it right to buy the rights in the market, as the subject suggests. The answer is not a straight ‘yes’ nor it is a ‘no’ as it all depends on several factors. To figure that out I did a quick back-of-the-envelope calculation.

What will it look like after Rights?

Firstly, I wanted to look at the effect of the Rights on the balance sheet, especially on the shareholders’ funds/book value.

With the proposed capital injection, the stated capital of the company is going to reach c. LKR6 billion as you can see from the Pro-forma section of the graph. On a pro-forma basis which converts to an adjusted book value per share of LKR46.22.

Similarly, some EPS calculations are shown below. 

As per my quick-and-dirty calculations, I forecast net profit attributable to shareholders of c. LKR981.5 million for the FYE15. On an adjusted basis this means EPS of c. LKR5.86.

KAPI trading multiples analysis

Then I looked at historical trading multiples of KAPI. 

From FYE12 through FYE14, KAPI has always traded at a discount to its book value (well before that it showed some errant movement). Ignoring FYE10 which was an outlier over the last five years, the average PBV during the last 4 years was 1.02x. It also recorded average PE of 7.13x over the same period. From the beginning of CY14 to date, it has traded at lowest PBV of 0.78x and PE of 7.71x and highest PBV of 1.93x and PE of 18.98x. Current multiples are also given in the graph. The Construction and Engineering sector is currently trading at PBV of 2.10x and PE of 17.7x.

Pricing post rights shares

I used relative pricing methods to gauge the price at which KAPI would trade post rights. Using average multiples and my earnings forecast, I obtain a price per share of LKR41.73. Similarly based on average PBV I derived a price per share of LKR49.17. (based on pro-forma numbers PBV based price of LKR47.04).

If I use the current multiples (which are very likely to continue post rights, unless there is a market crash), I obtain LKR62.42 and LKR69.95 respectively based on PE and PBV methods.

What is a right worth?

Rights are proposed to commence trading on 12 January 2015. If that is the case and assuming that post rights KAPI would trade at LKR62.42, I price a right at LKR17.42. I will be indifferent to buy rights at that price and if I can pick it up at any price below that I will be inclined to buy rights and execute.

If I take an alternative view and assume that my low end price is going to continue (i.e., LKR47.04) I wouldn’t opt to buy KAPI rights at any price above LKR2.04. But, chances are that this scenario is hardly unlikely.

Bottomline

There is a possibility that a trading profit be made by trading rights and also to buy KAPI at a lower price to profit from price adjustment post rights. Alternatively, I can buy KAPI and avail myself of the entitled rights which would make my average cost c. LKR56.94. Thereby, I can stand to benefit from post rights price adjustment (as I take the pricing view that it would trade at around LKR62.42. However, return potential depends on how much a right is priced at in the market when it starts trading. Well, everyone knows this and it's a fact, I guess. But, anyway, I suppose pricing effort of rights would give some inputs to a potential start.