A Buyer Should Pay Rs 202-245 For RIL Rights Entitlement Renunciation: Kotak

16 May 2020


New Delhi:  In cases of rights entitlement renunciation in the upcoming issue of Reliance Industries Limited (RIL), a buyer should pay the seller a theoretical fair value range between Rs 202 to Rs 245 for a fully paid rights entitlement, according to an analysis by Kotak Investment Bank.

Rights entitlement (RE) renunciation gives the buyer the rights to buy the shares at the Rights Price (equivalent to a strike price) as
against TERP/CMP (Underlying Price) and is dilutive in nature. Additionally, all the future upside/downside of the stock is left with
the Rights holder.

Kotak has simulated the fair value of the renunciation through pricing of this warrant. Warrant pricing is based on a slightly modified call option pricing calculator factoring in the dilutive nature.

Assuming it was a fully paid rights issue, Rs 1,257 (Strike Price) has to be paid before issue close, while the renunciation can be
bought at issue open till 4 days from issue close. Hence the period for the calculation has been kept as 4 to 15 days. This will be
compared to fully paid CMP of Rs 1,459 (Underlying Price).

At various assumptions of volatility and the balance 75% of the Rights being called at the end of one year, the theoretical fair value
ranges between Rs 202 to Rs 245, according to Kotak Investment Banking.

In case of a partly paid rights entitlement (RE), Rs 314 is paid upfront and Rs 943 (Strike Price) assumed after one year. The strike
price, however, will be compared to proportionate CMP of Rs 1,049 (Underlying Price) which is 75% of CMP of Rs 1,459.

The value of the RE in a fully paid Rights issue would be the difference between TERP/CMP and Rights price. Hence in this case, fair
value would be Rs 202 (Rs 1,459-Rs 1,257). At this level the buyer and seller of RE would break even.

In the partly-paid dynamic, the buyer is only getting 25% of the value of the renunciation price (Rs 202) on listing. However, if he pays 25% of the value to the RE seller i.e. Rs 50, then a value of Rs 152 is forever lost to the seller.

To normalise the same, the buyer should pay Rs 150, discounted by one year at an appropriate rate. "If we assume a discounting rate to be in the range of 12% to 14%, the proportionate value of the 3/4th portion will be Rs 131 to Rs. 134", the analysis said.

So the buyer should pay a theoretical fair value of Rs 181 to Rs 184 (Rs 50 upfront plus (Rs 131 to Rs 134)) to the seller in exchange of
the REs.