Key Takeaways
- TERP estimates share price after rights issue dilution.
- Calculated as weighted average of old and new shares.
- Helps investors decide whether to exercise or sell rights.
- Reflects theoretical value; actual price may vary.
What is Theoretical Ex-Rights Price (TERP)?
The Theoretical Ex-Rights Price (TERP) is the estimated share price immediately after a company issues new shares through a rights offering, reflecting the dilution effect on existing shareholders. It is calculated by combining the current market price with the discounted subscription price for new shares, helping investors understand the adjusted value of their holdings.
TERP is essential in evaluating the impact of a rights issue on equity value and guides decisions such as exercising rights or selling them. This concept also relates closely to dilution, which reduces the ownership percentage of existing shareholders.
Key Characteristics
TERP has distinct features that make it a practical tool for investors assessing rights issues.
- Weighted average price: Calculated as a blend of the market price of old shares and the subscription price of new shares.
- Reflects dilution: Shows the expected reduction in per-share value due to increased share count.
- Subscription price relationship: Comparison of TERP and subscription price helps determine the attractiveness of exercising rights.
- Assumes full subscription: The formula presumes all new shares are taken up; partial subscription affects actual outcomes.
- Market indicator: Post-issue trading prices often gravitate toward TERP, though market factors can cause deviations.
How It Works
TERP is calculated by dividing the combined market value of existing shares and the proceeds from new shares by the total number of shares after the rights issue. This method blends the higher market price of existing shares with the discounted price of new shares, providing a theoretical post-issue price.
Investors use TERP to assess whether exercising their rights is beneficial. For example, when TERP exceeds the discounted subscription price, buying new shares can add value. However, TERP is theoretical and does not account for market reactions, partial backstop agreements, or changes in company fundamentals.
Examples and Use Cases
TERP calculations are common in markets with frequent rights issues, helping shareholders evaluate their options and anticipate price adjustments.
- Airlines: Companies like Delta and American Airlines often use rights issues to raise capital, where TERP guides investors on the impact of new share issuance.
- Banking sector: Financial institutions such as Bank of America utilize rights offerings during capital raising, with TERP helping shareholders understand dilution effects.
- Energy companies: Firms like American Electric Power may implement rights issues to fund expansion, with TERP providing a benchmark for post-issue pricing.
Important Considerations
While TERP offers a useful estimate, it is important to remember that it is a theoretical price and actual market prices may fluctuate based on investor sentiment and other external factors. Additionally, if not all shareholders participate, the dilution and resulting price may differ from TERP.
Understanding TERP alongside concepts like paid-in capital and timing of early exercise can enhance your strategy when managing rights issues and protecting your investment value.
Final Words
The Theoretical Ex-Rights Price (TERP) provides a clear estimate of a stock’s value after a rights issue dilutes existing shares. To make informed decisions, compare TERP with the subscription price and current market price before choosing to exercise or sell your rights.
Frequently Asked Questions
TERP is the estimated market price per share immediately after a rights issue, reflecting dilution from new shares issued at a discount. It helps investors understand how the rights offering affects share value.
TERP is calculated using a weighted average formula that combines the value of existing shares and the proceeds from new shares issued at the subscription price. The formula is TERP = ((No × Po) + (Nn × Pn)) / (No + Nn), where No and Po are existing shares and price, and Nn and Pn are new shares and subscription price.
The share price often drops because a rights issue increases the total shares outstanding, diluting the equity value per share. TERP predicts this adjusted lower price by accounting for the discounted new shares issued.
Investors compare TERP to the subscription price; if TERP is higher, exercising rights may be profitable. If TERP is close to or below the subscription price, selling or ignoring rights might be considered.
No, TERP is a theoretical price based on full subscription and ignores real market reactions, partial subscriptions, and company fundamentals. Actual post-issue prices can differ due to these factors.
TERP is mainly used in markets where rights issues are common, such as the UK and India, to help maintain fairness for existing shareholders during capital raising.
If not all rights are exercised, the actual ex-rights price may differ from TERP since the formula assumes full subscription. This can lead to variations in dilution and share price adjustments.
Yes, prices often move toward TERP before the issue due to buying activity, which can increase volatility. After the issue, the share price typically settles near the TERP value.
