Rolls-Royce rights issue: all you need to know

We analyse the choices faced by Rolls shareholders, what they must consider and what happens next.

Rolls-Royce (LSE:RR.) rights issues - read our Frequently Asked Questions here.

An estimated 140,000 Rolls-Royce small shareholders will have a decision to make in the coming weeks after the engines giant unveiled plans for a £2 billion rights issue.

The fundraising is required to shore up the balance sheet after the Covid-19 crisis crippling the aviation industry contributed to the worst year in the company's stock market history.

Shares recently dived to a 17-year low and, to make matters worse for shareholders, the company has scrapped its final dividend for the first time since flotation in 1987.

Now those investors face seeing their holdings diluted by almost 77% if they do not participate in a rights issue that will increase the number of shares on the register by 333%.

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Buying all the new shares being offered at a heavily-discounted price will at least ensure that those shareholders protect their original investment, which they will want to do if they believe that Rolls has the potential to make a recovery from the current crisis. 

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Other shareholders may take the middle ground and sell some of their rights, so they are able to at least buy some of their entitlement. And there will be those investors who reject the idea of buying more Rolls shares outright and opt to sell their rights.

The fundraising is due to complete on 11 November, by which time many new and opportunistic investors are also likely to have jumped aboard so they gain the right to buy the heavily discounted new shares.

The Rolls story so far

There were 167,391 individual shareholders on the Rolls register at the end of last year, owning some 4.4% of the company. Of these, about 138,000 held fewer than 500 shares.

Many were allocated the minimum 150 shares by the Department of Trade & Industry in the 1987 privatisation, which was nine times subscribed by the public and Rolls-Royce staff and pensioners.

On the first day of trading — 20 May 1987 — the share price opened at 128.5p and subsequently moved beyond 200p before that year's stock market crash sent the price back to 112p.

Having peaked at 1,275p in December 2013, they were half that level by 2016 after Rolls slumped to a record loss of £4.6 billion and made its first dividend cut in 24 years.

A restructuring involving the loss of 4,500 jobs followed in 2018, which CEO Warren East said was necessary to create a business capable of competing with the likes of GE. He aimed to deliver annual cash flows of £1 billion by 2020, compared with just £100 million during the dark days in 2016.

Meeting that ambition was hindered by the cost of dealing with in-service issues on the Trent 1000 engine before being completely undone by the Covid-19 pandemic.  

East revealed in interim results in August that an alarming £2.8 billion of cash had haemorrhaged from the business after aviation industry shutdowns caused income from airline flying hours to dry up. Credit ratings agency Moody's cut Rolls to junk status in July.

How does Rolls plan to tackle its crisis?

The rights issue proceeds form part of £5 billion of additional liquidity the company is seeking to shore up its balance sheet in order to find a path through the uncertainty.

Alongside the £2 billion cash call, the company is planning to raise at least £1 billion from a bond issue. It also disclosed it has commitments for a new two-year term loan facility of £1 billion, plus support from UK Export Finance for a £1 billion extension to the 80% guarantee on an existing £2 billion five-year loan.

The new £1 billion loan facility depends on the rights issue being completed and the cancellation of the company's so far undrawn £1.9 billion credit facility.

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The company itself remains hopeful that some of the actions already taken, including plans for a major restructuring programme costing 9,000 jobs, can return it to a positive cash flow position during the second half of next year before achieving strong cash generation in 2022.

Outflows continued in July and August, although they were at reduced levels compared to the first half and modestly better than the company's own expectations. The current forecast is still for a full-year outflow of £4 billion, with the pathway to a recovery heavily dependent on the shape of the Covid-19 pandemic, particularly in relation to how it affects long-haul travel. 

Pandemic fundraisings

Premier Inn owner Whitbread has already gone down the rights issue route, when it raised £980 million by offering existing shareholders one new share for every two that they own.

Rights issues can take a few weeks to complete, whereas many companies in the current crisis have been able to jumpstart the process by offering new shares directly to institutions and without the delay of having to publish a detailed prospectus. Catering giant Compass raised £2 billion in this way, with easyJet making £419 million from City investors.

All shareholders usually have equal rights over new issues above 5-10% of the total share capital, but this threshold was temporarily raised to up to 20% following guidance from the Financial Conduct Authority and the Pre-Emption Group.

A rights issue affords small shareholders the same opportunity as institutions to buy the discounted shares, unlike the recent wave of share placings where many small investors have been left frustrated by their inability to participate.

In the case of Rolls-Royce, the amount of money it needed to raise meant it had little alternative but to undertake a rights issue.

What are the details of the Rolls rights issue?

In order to raise £2 billion, Rolls is issuing 6.4 billion new shares. This will give shareholders the right to buy 10 new shares for every three already owned, at a price of 32p per new share.

The move will increase the total number of Rolls shares in existence by 333%, from 1.93 billion to 8.37 billion. With so many new shares in circulation, shareholders will see their holding diluted by 77% if they don't take up their rights.

Shares were trading at 130p before the rights issue was announced on 1 October, meaning that pricing the new shares at just 32p represented a 75% discount.

But in reality, the discount is 41% based on the theoretical ex-rights price of 55p, which is the level when factoring in the impact of the new shares. The size of dilution will be influenced by the number of rights issue shares acquired during the cash call.

Should the company’s existing shares fall below the price the new ones are being offered at — as happened with banks such as Royal Bank of Scotland in  the financial crisis — there is no point subscribing, as you can buy the shares more cheaply on the stock market.

That doesn't look to be the case so far with Rolls shares, with the stock enjoying its best week since 1987 when it doubled in value to above 200p in the wake of the rights issue announcement.

What are the four choices facing existing Rolls investors?

• Subscribe for the new shares, which means you have to invest more money in the company. If you have 300 existing shares, for example, you have the right to buy 1,000 new shares at 32p. By buying all your rights for a total price of £320, you now have 1,300 shares and own the same percentage of the company as you did before the rights issue.
• You can choose to sell some of the shares so you can the buy rest with the proceeds. The number of shares you are able to buy will depend on what price people are willing to pay for the rights you are selling. But you will end up owning a smaller percentage of the total shares than you did before the rights issue.
• The third option is to sell all the rights. Again, the price achieved will depend on the price that people are willing to pay for those rights. Using the same example as above, you will still have 300 shares, but this will be a much smaller percentage of the company than before. 
• Do nothing and let your rights lapse. By doing so you will be diluting your stake in the company, including your entitlement to future dividend payments. If you do this, your rights will be offered for sale to other investors and you will be sent any proceeds by the company’s share registrar (minus expenses), if it’s £5 or more. 

What happens next?

Nothing can happen until there's been a general meeting of shareholders to approve the fundraising plan. This will be held on Tuesday, 27 October at 11am. To vote, participants must be on the Rolls-Royce share register by the previous Friday.

Approval at the meeting will trigger the dispatch of allotment letters to shareholders. The record date for entitlements under the rights issue will be the close of business on 23 October.

The existing ordinary shares will be marked “ex-rights” by the London Stock Exchange on 28 October, the same day as dealings in the nil-paid rights get underway. This nil-paid price is the difference between the issue price and ex-rights price.

The deadline if you are selling rights is 5 November, with the closing date for those taking up the rights or not selling being 6 November for interactive investor customers (the market deadline set by Rolls-Royce is 11th November). The result of the rights issue will be known by 8am on 12 November, when dealings in the new ordinary shares will also get underway.

Brokers will set an earlier response deadline for clients to take up the rights, so that they have time to compile and submit elections. Please refer to your corporate action notification for full details. Brokers will update client accounts upon receipt of new shares.

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Share certificates will be issued and accounts credited no later than 25 November.

The rights are potentially valuable, so if you aren’t sure what to do you should get some advice from a financial adviser and read the documentation and prospectus before making a decision. 

What do investors need to consider?

A recent share price above 200p presents a favourable City backdrop for the rights issue.

Retail investors have been piling in, with Rolls the most traded stock on the interactive investor platform in the days following the rights issue announcement. Buyers outweighed sellers by a ratio of almost 2 to 1.

Newcomers are likely to have been tempted by the opportunity to buy further shares in the rights issue at a heavily discounted level. One of the company's major shareholders, Los Angeles-based Capital Group Companies, has also upped its stake from 5% to almost 9% in recent days.

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City analysts at Berenberg believe the shares are worth 250p, while counterparts at Morgan Stanley reckon the measures more than adequately address questions around Rolls’ finances, particularly as the US bank's base case points to liquidity of £7 billion by the end of 2021.

For existing retail shareholders who are able to buy their rights in full in order to avoid being diluted, there are plenty of arguments in favour of getting involved.

The introduction of effective Covid-19 testing regimes at major airports has the potential to provide a much-needed boost to the flying hours that Rolls is so dependent upon. It's also worth remembering that there's much more to Rolls than just aero engines, with the defence and power systems arm underpinned by stable, longer-term contracts.

Looking further out, the company's focus on sustainable power also means Rolls is well-positioned to play a role in the world's transition towards a net-zero carbon economy.

There's also the possibility of takeover interest involving some or all of the company, with BAE Systems one potential suitor being mentioned. It's worth remembering, however, that the UK government still holds a “golden share” in Rolls, which could stymie an overseas bidder.

Some investors have already used the recent share price rally as a good point to get out, with sellers making up a third of trading activity on the ii platform. There is still so much uncertainty surrounding the outlook for the recovery in the aviation industry, that many investors will be rightly concerned they are pouring good money after bad in the rights issue.

And there's no guarantee that the fundraising is going to be sufficient. Indeed, the company's own “severe, but plausible, downside scenario” in August's interim results highlighted that a second wave of Covid-19 would leave it needing to draw down a £1.9 billion revolving credit facility.