The Rolls-Royce (LSE: RR) share price has been on a one-way move for most of this year. The trend has been downwards, losing around 84% in value. Unfortunately, it’s indirectly tied to the fate of the airline industry. With a report I read earlier this week commenting that flying miles have halved due to the pandemic, demand for Rolls-Royce engines and maintenance is just not there.
Thanks to restrictions being lifted somewhat in recent months, most consumers can travel if they have to. But with demand unlikely to return in the short term, the board at Rolls-Royce are needing to secure funding to see the share price stabilise. In response to this, they’ve turned to a rights issue.
What’s a rights issue?
A rights issue is an tool used by companies to raise new money. In this case, £2bn is expected to be raised. In essence, existing shareholders are offered the ‘right’ to buy new shares in the company, at a discounted price. The terms are stipulated in advance, for example allowing you to buy one new share for every two existing shares you hold. For existing shareholders, taking up the offer means that their shareholding is not diluted, even though new shares are issued. For the company, additional money is raised through the new shares issued.
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In this case, the rights issue is 10 new shares for three existing ones, at a price of 32p. This is at a steep discount to the current Rolls-Royce share price, which trades around 104p. This means that the share price will fall when the ex-rights price kicks in. The exact ex-rights price can be calculated, but will be a blended average of the existing shares plus the new shares, divided by the monetary value of them. In this case, it’ll be lower than 100p easily.
What should investors do about the Rolls-Royce share price?
The share price has already been falling since the news was announced, and is down 10% in trading so far today. The rights issue is needed to raise emergency capital for the business, which is a worrying sign. A bond issuance is also being decided on, with the total amount due to be raised around £5bn.
For a firm that was once the poster child of British industry, the recent moves are concerning. Therefore, I wouldn’t be buying the stock at the moment, or even after the shares go ex-rights. The airline industry shows no signs of making a strong bounceback, and so I’d look elsewhere for value.
I recently wrote about how I’m favourable on the M&G share price. Similar to Rolls-Royce, you can buy the share at a good discount to where we started the year (35%). But the fundamentals surrounding the business are stronger. Added to this is a dividend yield which sits above 10%. This is very attractive for income investors, but the share price slump also should attract longer-term value investors.
Overall, the rights issue will mean the Rolls-Royce share price will fall. Yet I think the share price will fall even without the rights issue, due to poor fundamentals, so would stay clear of investing.
