• TERP (theoretical ex-rights price) is the estimated market price per share immediately after a rights offering is completed.
– TERP is calculated by dividing the total market value of the company (pre-offer) plus cash raised from the offering, by the total number of shares outstanding after the offering.
– TERP is usually lower than the pre-offer share price because rights are normally offered at a discount and increase the share count (dilution).
– TERP is a theoretical number: actual post-offer prices can differ because of trading, partial subscription, underwriter actions, taxes, and other market factors.
Source: Investopedia
Theoretical ex-rights price (TERP) explained
A rights offering lets existing shareholders buy additional shares in proportion to their holdings, usually at a discount and for a limited period. TERP is the “fair” per-share price after the rights offering is settled, assuming a particular level of subscription. It’s used to estimate dilution and to value the tradable rights themselves. TERP is especially useful during the offering period for comparing the pre-offer price, the rights’ market value, and the economics of exercising versus selling rights.
TERP — simple formula and intuition
General formula (when all rights are exercised):
TERP = (N * P0 + NewShares * Pe) / (N + NewShares)
Where:
– N = number of existing shares (can cancel out if working in per-share terms)
– P0 = current (cum-rights) market price per share before the offer
– NewShares = number of new shares issued (or r * N, where r = new shares per existing share)
– Pe = subscription (offer) price for the new shares
If you express new shares as a ratio r (new shares per existing share), the per-share formula simplifies to:
TERP = (P0 + r * Pe) / (1 + r)
Value of a right (theoretical)
– Theoretical value of one right (per existing share) = P0 – TERP
This is the amount the right contributes to the pre-offer (cum-rights) share price. If rights are freely tradable, their market price should be close to this theoretical value (ignoring transaction costs and market moves).
Worked example (clear numbers)
– Pre-offer price (P0): $50
– Rights offer: 1 new share for every 4 existing shares (s = 4) → r = 1/4 = 0.25
– Offer price (Pe): $30
Step 1 — compute TERP:
TERP = (P0 + r * Pe) / (1 + r) = (50 + 0.25 * 30) / (1 + 0.25) = (50 + 7.5) / 1.25 = 57.5 / 1.25 = $46.00
Step 2 — theoretical value of a right:
Value per right = P0 – TERP = 50 – 46 = $4.00
Interpretation: After the issue the share is worth $46 (theoretical). Each existing share carried a right worth $4 before the ex-date. If you hold four rights you can buy one share for $30 and that share should be worth $46 after the deal — a $16 theoretical gain, which equals four rights × $4.
When TERP depends on subscription rate
The TERP above assumes the stated number of new shares are actually subscribed (e.g., fully taken up). If only a fraction x of rights are exercised (partial take-up), replace r with r*x in the simplified formula
TERP(x) = (P0 + r*x * Pe) / (1 + r*x)
So TERP falls (less dilution) if fewer rights are exercised, and it falls further toward P0 if very few new shares are issued. In practice you may model several scenarios (25%, 50%, 75%, 100%) to see how outcomes change.
Important — assumptions and limitations
– TERP is theoretical: it assumes no other market-moving news, and it depends on the assumed subscription rate.
– If rights trade, supply/demand can push the rights’ market price away from the theoretical value.
– Unexercised rights may be sold on exchanges (if tradable), or the company/underwriters may deal with unsubscribed shares, changing actual dilution.
– Transaction costs, taxes, and settlement timing can affect real returns from exercising or trading rights.
– News, macro moves, or company performance during the subscription period can move P0 and TERP materially.
Investor analysis — practical considerations
1. Compute TERP and the theoretical value of a right:
• Use the formulas above to get a baseline for decision-making.
2. Decide among three basic choices (if you’re an eligible shareholder):
• Exercise your rights to maintain your ownership percentage (pay Pe). Good if you believe long-term fundamentals justify the cost.
• Sell your rights (if they’re tradable) to capture their immediate value without putting in new cash.
• Do nothing (let rights lapse). This is rarely optimal unless the rights have negligible value or transaction/financing costs outweigh benefits.
3. Consider alternatives and arbitrage:
• If tradable, a common arbitrage is to buy the rights (or underlying shares) and offset positions to lock in the theoretical spread — but this requires precise execution, low transaction costs, and certainty about subscription rules.
• Compare the effective cost per new share (Pe) to the investor’s required return and to the TERP.
4. Account for dilution and voting power:
• If you don’t exercise and others do, your ownership and voting power shrink. Quantify this before deciding.
5. Model multiple subscription scenarios:
• Run TERP for 25%, 50%, 75%, and 100% subscription to understand upside/downside outcomes.
6. Factor taxes and financing:
• Determine how purchased shares and any gain from selling rights are taxed in your jurisdiction. Also assess borrowing costs if you fund the exercise with margin.
Practical step-by-step guide (what to do)
1. Gather the offer details:
• Pre-offer price (P0), offer price per new share (Pe), and the subscription ratio (e.g., 1 for 4). Also confirm whether the rights are tradable and the offer expiry.
2. Calculate r (new shares per existing): r = (new shares allowed) / (existing shares to get those new shares). For “1 for 4,” r = 1/4 = 0.25.
3. Compute TERP: TERP = (P0 + r * Pe) / (1 + r).
4. Compute theoretical right value: P0 – TERP.
5. Price scenarios for partial take-up: substitute r*x for r using different x (take-up rates) and recalculate TERP.
6. Compare options:
• If exercising, what is the implied price per post-offer share relative to your valuation?
• If selling rights, is the rights market price close to the theoretical value? Account for fees.
• If doing nothing, quantify dilution and lost value.
7. Decide and act before the subscription deadline; if rights are tradable, consider selling if you do not want to invest more cash.
Real-world example (scenario analysis)
Using the earlier numeric example (P0 = $50; 1 for 4 at $30):
– Full subscription (100%): TERP = $46; right value = $4.
– If only 50% subscribe: r*x = 0.25 * 0.5 = 0.125 → TERP = (50 + 0.125*30)/(1 + 0.125) = (50 + 3.75)/1.125 = 53.75/1.125 ≈ $47.78. Right value ≈ 50 − 47.78 = $2.22.
This shows partial subscription reduces dilution and increases TERP (closer to P0).
When rights are tradable — simple arbitrage idea
If rights are tradable and mispriced, an arbitrageur might buy rights and exercise them (or buy rights and underlying shares in specific ratios) to capture the difference between exercise economics and market prices. These trades require careful execution, capital, and low transaction costs — and they carry risk if market moves or the subscription rules change.
Why companies use rights offerings
– Raise new capital while giving existing shareholders preemptive rights (minimizes ownership dilution for those who participate).
– Often cheaper than other equity issuance methods and can be perceived as fairer to current shareholders.
– Management can target funding needs while attempting to limit shareholder discontent.
Summary
TERP is a practical, easy-to-calculate estimate of where a share “should” trade after a rights offering, and it is essential for valuing rights and evaluating exercise vs. trade decisions. But TERP is theoretical — real outcomes depend on actual subscription rates, market behavior, transaction costs, and tax treatment. Use TERP as a planning and comparison tool, model multiple subscription scenarios, and consider execution costs and corporate details before acting.
Reference
– Investopedia: “Theoretical Ex-Rights Price (TERP)” —
(Continuation)
Additional sections
How TERP changes when subscription take-up is incomplete
– The basic TERP formula (TERP = (P0 × N + PR × M) / (N + M)) assumes the full rights issue is subscribed (all new shares are taken up). In practice, not all shareholders exercise their rights. If only a fraction t (0 ≤ t ≤ 1) of the offered new shares are subscribed by existing shareholders, the post-issue share count and cash raised change and so does the observed market outcome.
– Adjusted calculation when only a portion t of the offer is taken:
• Let N = existing shares; M = maximum new shares offered (if fully subscribed); t = fraction of M actually subscribed.
• New shares actually issued = t × M.
• Adjusted TERP = (P0 × N + PR × (t × M) + value_of_unsold_shares_converted_or_offered_elsewhere) / (N + t × M).
– Important: How unsubscribed shares are handled (offered to underwriters, placed on the market, or cancelled) matters. If underwriters take remaining shares at PR, the cash raised equals PR × M regardless of shareholder take-up and the simpler TERP formula using full M still applies. If unsubscribed shares are sold at a different price, you must incorporate that proceeds level into the numerator and the actual issued share count into the denominator.
Step-by-step practical guide for calculating TERP (simple, full-subscription case)
1. Gather inputs:
• P0 = pre-offer market price per share (last traded price on record date).
• N = number of shares currently outstanding.
• Offer terms: how many new shares for how many existing (e.g., “1 for 4”), or equivalently the total number of new shares M to be issued if fully taken up.
• PR = subscription (offer) price per new share.
2. Compute the total pre-offer market value = P0 × N.
3. Compute cash to be raised if fully subscribed = PR × M.
4. Compute total shares outstanding after issue = N + M.
5. Plug into the TERP formula:
• TERP = (P0 × N + PR × M) / (N + M).
6. Interpret: TERP is the theoretical ex-rights price per share immediately after the issue if the market values the company at pre-offer market capitalization plus the cash raised (i.e., no immediate re-rating for other reasons).
Worked numeric example (1 — full subscription; 1-for-4 rights)
– Scenario:
• Pre-offer price P0 = $20.00
• Company announces 1 new share for every 4 existing shares (1-for-4). So if N = 100 million existing shares, M = 25 million new shares.
• Subscription price PR = $12.00
– Calculation:
• Pre-offer market value = 20 × 100m = $2,000m
• Cash raised = 12 × 25m = $300m
• Shares after issue = 125m
• TERP = (2,000m + 300m) / 125m = 2,300m / 125m = $18.40
– Intuition:
• TERP ($18.40) is lower than P0 ($20.00) because the company issued discounted shares, increasing the share count and diluting per-share value.
• The theoretical value of the right attached to each pre-offer share = P0 − TERP = $20.00 − $18.40 = $1.60. That represents the per-share entitlement value embedded in the pre-offer share. If rights are tradable, their theoretical price before the ex-date is often close to this.
Worked numeric example (2 — alternate offer ratio and partial take-up)
– Scenario A: 1-for-2 offer, P0 = $50, PR = $30, N = 10m, M (max) = 5m if fully subscribed.
• TERP (full subscription) = (50 × 10m + 30 × 5m) / (15m) = (500m + 150m) / 15m = 650m / 15m = $43.33.
• Value of right per existing share = 50 − 43.33 = $6.67.
– Scenario B: Same offer but only 60% take-up by shareholders (t = 0.6). New shares actually issued = 0.6 × 5m = 3m.
• Cash raised = 30 × 3m = 90m
• Shares outstanding after = 10m + 3m = 13m
• Adjusted TERP = (50 × 10m + 90m) / 13m = (500m + 90m) / 13m = 590m / 13m = $45.38
• Note: Adjusted TERP ($45.38) is higher than the full-subscription TERP ($43.33) because fewer discounted shares entered the market (less dilution); but it differs from what investors might have expected before the take-up outcome was known.
Interpreting differences between TERP and market price
– TERP is a theoretical construct assuming capitalization = pre-offer market cap + cash raised and that market participants value the enlarged company at that level.
– In practice, the market price after the ex-date may differ from TERP because:
• Investors revise expectations about the company’s prospects as a result of the capital raise (positive or negative).
• Market sentiment, liquidity, or supply/demand for shares and rights drive price away from the theoretical.
• Underwriting arrangements, unsold share placement, or additional fees/expenses reduce net proceeds and change the effective dilution.
– Therefore TERP is best viewed as an arithmetic benchmark, not a guaranteed post-issue price.
How to value an individual tradable right (practical)
– If rights are detachable and tradeable, their theoretical pre-ex-date price per right is often approximated by:
• Value of right per existing share = P0 − TERP.
– Example (from earlier 1-for-4 case):
• P0 = $20; TERP = $18.40; theoretical right value = $1.60 per right.
– If multiple rights are needed to subscribe for one new share (e.g., 4 rights → 1 new share), the buyer of those 4 rights plus PR pays the equivalent of TERP for the newly created share:
• 4 × ($1.60) + $12 = $18.40 = TERP.
– Caveat: Market prices of rights can deviate from P0 − TERP because of transaction costs, liquidity, speculation, or differences in expected take-up.
Common investor choices around rights offerings (practical steps and considerations)
1. Exercise rights and hold new shares:
• Pros: Maintain ownership percentage (avoid dilution), cheap way to buy more shares.
• Cons: Requires cash outlay; if you’re short on cash, this may be unattractive.
• Practical steps: Verify deadline, complete subscription form or use broker facilities, ensure cash availability.
2. Sell rights on the market:
• Pros: Monetize the entitlement without additional cash outlay; can be attractive if rights price is near fair value and you don’t want to increase holdings.
• Cons: If rights undervalued relative to fundamentals, selling could forgo value.
3. Buy additional rights:
• Pros: Acquire more rights if you want to increase ownership beyond your pro rata share, often cheaper than buying full shares on market.
• Cons: Rights are time-limited; buying rights requires understanding their fair value and the subscription mechanics.
4. Let rights lapse:
• Pros: No action/no cash required.
• Cons: Automatic dilution of ownership proportion and potential loss of value of the right if it had positive value.
5. Hedged/arbitrage strategies (for sophisticated investors or market makers):
• Example: Prior to ex-date, sell the underlying stock and buy the rights to lock in a theoretical arbitrage if market prices diverge from TERP, but this requires precise execution and collateral and carries execution and model risk.
Other effects to monitor
– Earnings per share (EPS) dilution: TERP gives an idea of arithmetic dilution in price per share, but EPS effects depend on how the raised capital is used (e.g., debt repayment, investment) and on post-issue earnings.
– Market capitalization: Theoretical post-issue market cap under the TERP assumption equals pre-offer market cap + cash raised (neglecting fees and market repricing). That helps show why TERP is lower than P0 when more shares are issued at a discount.
– Underwriting fees and issuance costs: Net proceeds are reduced by fees, which reduce TERP slightly; include net cash raised (after fees) when calculating a more realistic TERP.
– Taxation: In some jurisdictions, exercising rights or selling rights has tax consequences (capital gains, ordinary income) — consult a tax advisor.
Limitations and common pitfalls
– Using stale or volatile P0: If the pre-offer price is volatile, the TERP computed from a single last-trade price might be misleading.
– Ignoring underwriting and placement of unsubscribed shares: These arrangements materially affect the actual outcome.
– Assuming markets are efficient and will move to TERP immediately: real markets may take time or move to a different level entirely.
– Confusing “value of a right” formulas: be explicit whether the right you refer to is the per-existing-share entitlement (common) or a right bundle required to subscribe for one full new share.
Additional real-world example (multiple subscription scenarios)
– Company XYZ:
• P0 = $10
• Offer: 1 new share for every 5 existing shares (1-for-5), so m = 5
• PR = $6
• N = 60m existing shares, M (max new) = 12m
– Full subscription (t = 1):
• TERP = (10×60m + 6×12m) / (72m) = (600m + 72m) / 72m = 672m / 72m = $9.333
• Right per share = 10 − 9.333 = $0.667
– Partial subscription (t = 0.5; 50% taken up):
• New shares = 6m; cash raised = 6×6m = 36m
• Adjusted TERP = (600m + 36m) / 66m = 636m / 66m = $9.636
• Notice TERP is higher (less dilution) when fewer discounted shares are issued.
Practical checklist for investors facing a rights offering
– Read the offer circular carefully: terms, ratio, subscription price, deadlines, whether rights are tradable, and how unsubscribed shares are handled.
– Calculate TERP (and adjusted TERPs for different take-up assumptions) to understand potential dilution and rights value.
– Decide among exercising, selling, buying, or letting rights lapse based on:
• Your cash availability
• Long-term view on the company
• Current rights market price versus theoretical value
• Transaction costs and tax implications
– Confirm execution mechanics with your broker well before deadlines.
– If considering arbitrage or hedging strategies, ensure you understand margin/settlement implications and execution risk.
Concluding summary
– Theoretical Ex-Rights Price (TERP) is an arithmetic benchmark that estimates the post-rights-issue share price assuming the new shares are issued at the offer price and the market values the enlarged company at pre-offer market cap plus the cash raised.
– TERP is calculated as (pre-offer market value + cash raised from new shares) divided by (total shares after issue). A common compact formula for a “1 for m” offer is TERP = (m × P0 + PR) / (m + 1).
– TERP helps investors estimate the effect of the rights issue on per-share value and to value tradable rights (approximate right value per share = P0 − TERP in many cases).
– In practice, actual post-issue prices can differ from TERP because of partial subscription, underwriting arrangements, market repricing, issuance costs, and investor sentiment. Thus TERP is a useful tool but not a guarantee.
– Before acting, investors should run through practical calculations for different subscription scenarios, check broker mechanics and deadlines, and consider tax and liquidity implications.
Source
– Investopedia: “Theoretical Ex-Rights Price (TERP)” —