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REITs and rights issues: Dilutive or not?

Monday, October 31, 2011

I was not the best Science student, that is for sure. I made the switch from Science to Arts at the advice of my school principal when I was in secondary school and that was probably the best advice during my school days in terms of my academic life.

I do, however, remember the scientific concept of "dilution". To me, it is quite simple. 

If I had half a glass of orange juice and I added half a glass of water to it, it would taste quite bad. Diluted and, in this case, half as concentrated.

However, if I had half a glass of orange juice and I added another half a glass of the same type of orange juice to it, would it taste any different? 

No, it would taste the same. 

Concentration stays the same. Not diluted.

There has been quite a bit of talk in cyberspace that rights issues by REITs are dilutive if we as unitholders do not participate in them. 

Some would even say that the REITs are taking back the income they distributed to unitholders before. 

Thinking of rights issues in such a manner is like suffering from cataracts. These people are not seeing things clearly.

If a REIT's distribution yield was 10% and after rights issue, it remained at 10%, would it "taste" less delicious? 

No, it would still be giving me the yield I had enjoyed before the rights issue. 

The rights issue would be simply providing me an option to increase my investment in the REIT for the same distribution yield, doubling future income in nominal value.
However, if I did not participate in the rights issue and chose to sell away the nil-paid rights instead, would the distribution yield for my remaining investment in the REIT be lower? Probably so.

However, since we had sold the nil-paid rights, the cost of our original investment would be lowered and the distribution yield would, thus, be higher. 

Theoretically, therefore, we would not be worse off in terms of distribution yield if we chose not to subscribe to the rights issue.

Most arguments which say that unitholders would see dilution if they did not take part in rights issues are referring to how their shares of the enlarged capital base would shrink in percentage terms. 

This argument, apart from being academically appealing, holds no pragmatic significance for me.

Having said this, not all rights issues are distribution yield accretive. Each rights issue should be assessed based on the circumstances leading to it and its pro forma numbers. 

Equity fund raising as a concept is simple enough to understand. 

To have a simple blanket statement that unitholders not taking part in rights issues would see dilution is, however, too simplistic and ignores what is most important about investing in REITs: income.

22 comments:

Singapore Man Of Leisure said...

Comrade!

We have something in common :) We are both from the Arts stream (although technically I am in the sub-science stream).

During the streaming process after sec 2, I was posted to the Science stream... However, I decided to volunteer the swith to the Arts stream. Anything to get out of studying Additional Maths!!!

I was the only one in my batch to do so - even after our vice-principal used me as an example to encourage other students to follow their interests - not what's supposed to be good for them.

I guess during my time, "smart" students were "expected" to go to the Science stream (then can become doctors and engineers mah!); while students with lower grades go to Arts... Poor idealists... (Can get good job learning history or literature meh?)

AK71 said...

Hi SMOL,

You are amazing. A blog post about REITs and rights and you zoomed in on what I did in school! ;)

Well, you were braver and obviously had a mind of your own even then. My parents were so proud that I was sent to the top class which was a pure science class, i.e. triple science and double maths. They probably thought I could end up being a doctor. I am a disappointment. :(

I did terribly for Chemistry. I did very well for Biology and E.Maths. I was so so in Physics and A.Maths. Needless to say, I did very well for English Language and Geography. Anyway, I enjoyed JC and NUS a lot more. Arts! Yeah!

My principal probably used me as an example of how we should have self-knowledge and not wear shoes too big for our feet. :(

Oh, my school didn't have an Arts stream, only Science or Sub-science. Philistines!

Singapore Man Of Leisure said...

Hee hee,

I see what I want to see. Sticking my tongue out. Ha ha!

It's "sub-science" for me, but my mind always call it Arts - Physical science and Biology plus History and Literature.

I did not do pure Arts as I don't want to drop Biology for Geography. I am a fan of all those documentaries on animals and plants. I would love to be a naturalist like David Attenborough!

Life is a series of choices ;)

Sorli sorli. I better step aside for others who may want to comment or challenge your post on Reits and Rights issues.

Createwealth8888 said...

Read? Right issue back again (6)

Paul said...

Hi Ak

I'm reading from yr post that you do not belong to the 'Rights Issue is Bad!' School of Thought. Or more accurately, not all rights issue are bad.

I always have issues with the 'dilutive' argument cos none of us own significantly large no of shares anyway for it to be meaningful. Neither does any of us has any grand plan of controlling the REIT so why should it be just a big deal our shares are diluted; provided the yield remains largely unchanged.

Thanks for articulating the issues so well. Next time anyone sprung this debate, I think I will point to yr post.

< P A U L>

la papillion said...

Hi AK,

Reit rights trading is what I do well, judging from past experiences. I see it as an opportunity to make some money from the arbitrage. If u know the fair value of something and the price of it, would you not take a calculated risk, esp if backed by a high yield? Let people say what they like. Times like this is a godsend for reits.

AK71 said...

Hi SMOL,

So des ne. We could have been from the same school! haha.. ;p

I love both Biology and Geography, doing well for both subjects. It would have been a tough choice if I had to give up one or the other. However, since Geography was my only Arts subject, pragmatically, I would have had to give up Biology.

David Attenborough? Strangely, I could actually visualise you as the Asian version. Hmmm.. Wonder why. ;)

AK71 said...

Hi CW,

Thanks for sharing the link. :)

AK71 said...

Hi Paul,

Please feel free to share my blog posts with anyone whom you think might be interested (or misguided as the case may be). ;p

I have been asked questions on this issue many times before but I didn't bother to blog about it until I was asked this same question again (for the umpteenth time) today.

So, I finally decided to do a blog post on the topic which I could then paste a link to every time people bring up the topic in future.

I hope it goes some way to correcting misconceptions about rights issues carried out by REITs. :)

AK71 said...

Hi LP,

Yup, I always say I do not believe in being overly bullish or bearish, I believe in being pragmatic. If it is an exercise that is likely to bag me some gains, why wouldn't I like it? ;)

Here is to more money making rights issues by S-REITs! Huat ah! ;p

mark said...

I only got this to say - Don't care white cat or black cat. As long as can catch the mouse (make money) it is a good cat.

End of the day, it is about making money, passive income etc. While it is easy to say one shouldn't be attached emotionally (positively or negatively) even I am guilty of it. S chips may make one a lot of money if invested the right way, but I have near zero faith and trust in them, hence I stay out. End of the day, to each their own. There are naysayers to virtually everything, REITs included.

To each their own. Cat theory.

PS - I am vested in REITs. I don't fall in love with it, but I like it. Not everything I have is vested in REITs.

Ah John said...

I think dilute or not must depend on the money you put in can generate extra distributable income or not, eg. If the money just to pay debt , then no more income, or save some interest cost only. Another example, Buffett doesnt pay dividend because he believes he can use the money to grow more quickly than normal people.

SnOOpy168 said...

@CW - link error. or wad it my browser ?

@AK -i do like rights. had fun & profits with First & Aims. i am still learning to keep some cash on hand in case the next rights shows up. Only if it makes sense and profit. i skipped Cityspring totally. no point throwing good money away like this.

now trying to see how much i can afford & cheong on the Lippo rights issue.

AK71 said...

Hi Mark,

Indeed, one man's meat could be another man's poison. We can always agree to disagree, of course.

However, I am a person of reason and I have almost zero tolerance for people who are unreasonable. More often than not, these are close minded people. So, instead of getting into a debate with them which is a waste of time and energy, I simply avoid talking to them these days. :)

AK71 said...

Hi Ah John,

Yes, I keep making this same point.
Rights issues for yield accretive activities are good. Rights issues to strengthen balance sheets? It probably means that the balance sheets must be crap in the first place. Run away. ;p

As for Warren Buffet, well, how many Warren Buffets are there in the world? I rather have the companies I invest in pay me good dividends than to trust that they will continue to create more value by growing their businesses. A bird in hand is better than two in the bushes. ;p

AK71 said...

Hi SnOOpy168,

I am glad you had fun on top of making some money from rights issues so far. :)

I am also waiting for LMIR's nil-paid rights to start trading. Let's see if we can make some pocket money again. ;)

CK said...

Hi AK,

The nil-paid right, how does it work when it is trading? Does it mean that ppl who have the right to the right shares can sell theirs right share on SGX ? And we can buy from there ? Sorry i am still a newbie to investment and learning on the way. What abt the application for excess right share ?

AK71 said...

Hi CK,

Yes, existing unitholders given renounceable rights can sell these rights away if they choose to. These rights are then known as "nil-paid".

Anyone interested could buy these rights from the sellers and pay the requisite amount before the deadline to convert these into new units in the REIT.

As for excess rights, you have to be an existing unitholder to qualify for excess rights application.

You will receive a form from SGX if you should qualify. This is usually together in a package of information which will tell you how to go about the application. Good luck. :)

mark said...

U getting old liao mate!

I am still the angry bird. My nick name at the work place. I got 2 of it in my car.. :P

AK71 said...

Hi Mark,

You are most probably right. As I age, I become more apathetic. So, you are an Angry Bird, I am a Green Pig? ;p

Anonymous said...

I like this orange juice analogy, could never have thought of it as interestingly the way you do. :)

I also didn't know there was such streaming in secondary school, I only know normal, express and SAP haha

Blackjack

AK71 said...

Hi Blackjack,

Well, I could have been more atas, of course. Maybe, cranberry juice or mulberry juice? Haha... Nah, I am a simple person and orange juice came to mind. So, orange juice it is. :)

Streaming took place after the final exams in Sec 2. It didn't happen to you? That's strange. Didn't your school have to decide which stream to put you in: Pure Science, Sub Science, Arts or Technical?

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