Theoretical Ex-Rights Price

The Theoretical Ex-Rights Price (TERP) is the estimated price of a company's shares immediately after a rights issue. Think of it as a calculated forecast, not a market guarantee. When a company wants to raise more capital, it can offer its existing shareholders the “right” to buy new shares, typically at a discount to the current market price. The TERP is the expected, blended price of the shares once these new, cheaper shares are factored in. Because more shares are being created, the value of the company is spread over a larger number of shares, an effect known as share dilution. The TERP gives investors a clear mathematical benchmark for what the new share price should be, stripping out the noise and emotion of the market. It's the “on paper” price after the dust settles.

For an ordinary investor, the TERP is more than just an academic number; it’s a vital tool for decision-making. When a company announces a rights issue, you, as a shareholder, face a choice:

• Exercise your rights: Buy the new shares at the discounted subscription price.
• Sell your rights: If the rights are tradable, you can sell them to other investors.
• Do nothing: Let your rights expire, which usually means losing their value and having your ownership stake diluted.

The TERP is your guide in this decision. It helps you understand the immediate financial impact of the rights issue on your investment. By comparing the TERP to the stock's price when it starts trading ex-rights (without the right to buy new shares attached), you can gauge the market's reaction. If the actual market price holds above the TERP, it might signal that investors are optimistic about how the company will use the new cash. If it plummets below the TERP, the market may be signaling its disapproval.

Calculating the TERP is straightforward and empowering. It lets you see past the headlines and understand the mechanics of the share price change.

The most common formula to find the TERP is: TERP = [(Number of Old Shares x Cum-Rights Price) + (Number of New Shares x Subscription Price)] / (Total Number of Shares After Issue) A simpler version, focusing on the basis of a single new share, is often easier to use: TERP = [(N x P) + S] / (N + 1) Where:

• N: The number of old shares you need to own to be entitled to buy one new share.
• P: The Cum-Rights price of one share (the market price before it goes ex-rights).
• S: The Subscription Price for one new share.

Let's say you own shares in “Innovate Corp.” The stock is currently trading at $20 per share. Innovate Corp. announces a 1-for-5 rights issue.

• What this means: For every 5 shares you own, you can buy 1 new share.
• Subscription Price: The company offers these new shares at a discounted price of $15.

Let's plug these numbers into our simplified formula:

• N = 5 (you need 5 old shares for the right)
• P = $20 (the current, cum-rights price)
• S = $15 (the subscription price for the new share)

Calculation: TERP = [(5 x $20) + $15] / (5 + 1) TERP = [$100 + $15] / 6 TERP = $115 / 6 TERP = $19.17 So, the Theoretical Ex-Rights Price is $19.17. You would expect the share price to drop from $20 to around $19.17 on the day it begins trading ex-rights.

For a follower of value investing, the TERP is just the beginning of the analysis, not the end. A value investor knows that price is what you pay, but value is what you get. The dilution shown by the TERP calculation is not inherently good or bad; its quality depends entirely on how the company's management intends to use the fresh capital. The crucial questions are:

• Why is the money being raised? Is it to fund a high-return expansion project that will grow the business's intrinsic value over the long term? Or is it to cover operational losses and pay down debt from past mistakes—a sign of a struggling business?
• Is management a wise capital allocator? Does the leadership team have a track record of investing capital effectively to generate strong returns for shareholders?

A true value investor sees a rights issue not as a simple mathematical event but as a critical test of management's strategy. If the new funds are destined for a profitable venture, then buying discounted shares via the rights issue could be a fantastic opportunity to increase one's stake in a wonderful business at a fair price. Conversely, if it's a desperate cash grab for a failing company, even a deep discount is no bargain. The TERP tells you the new price, but only a deep dive into the business tells you the real value.