Theoretical Ex-Rights Price (TERP)

The Theoretical Ex-Rights Price (also known as TERP) is the estimated market price of a company's shares immediately following a rights issue. Think of it as the 'blended' price, a calculated average that accounts for both the original shares trading at their old price and the new shares being issued at a discounted price. It’s theoretical because it's a mathematical forecast, not an actual traded price. The real market price might open higher or lower due to market sentiment, news, or other factors. However, TERP provides a crucial benchmark for investors. It helps you gauge the immediate impact of the rights issue on the share price and provides a reference point to decide whether to exercise your rights (buy the new shares), sell your rights to another investor, or simply let them expire.

Imagine a company wants to raise money. Instead of going to a bank, it turns to its loyal owners: its existing shareholders. This is a rights issue. The company offers them the 'right' to buy new shares, usually at a price below the current market value. This discount is a sweet-talker's way of encouraging participation. But this creates a mathematical wrinkle. You have a pool of old shares trading at, say, $10, and a new batch of shares about to be created at a subscription price of, say, $7. When these two pools mix, what's the new, fair price? It can't be $10, because that ignores the cheaper new shares. It can't be $7, as that ignores the more valuable old ones. TERP solves this puzzle. It calculates the weighted average value per share after the new capital has been raised and the new shares have been issued. It’s like mixing a bottle of vintage wine with a bottle of a good table wine. The resulting blend won't have the price of the vintage, nor the table wine; it will have a new, intermediate price that reflects the value of both. TERP is the per-share price of that new blend.

The concept might sound complex, but the math is straightforward. It’s all about adding up the total value and dividing by the new total number of shares.

The logic is simple: TERP = (Market Value of All Old Shares + Cash Raised from New Shares) / Total Number of Shares After the Issue

Let's say our favorite company, 'Euro-American Gadgets Inc.', needs cash for a new factory.

1. Step 1: The 'Before' Picture
   • Euro-American has 10 million shares in circulation.
   • The current share price (this is called the 'cum-rights' price) is $10.
   • The company's Market Capitalization is 10 million shares x $10/share = $100 million.
2. Step 2: The 'Offer'
   • The company announces a '1-for-5' rights issue. This means for every 5 shares you own, you get the right to buy 1 new share.
   • The subscription price for these new shares is $7 (a nice discount to the $10 market price).
   • Number of new shares to be issued: 10 million / 5 = 2 million new shares.
3. Step 3: The 'Calculation'
   • Value of Old Shares: 10 million shares x $10 = $100 million
   • Cash Raised from New Shares: 2 million shares x $7 = $14 million
   • Total Value of Company Post-Issue: $100 million + $14 million = $114 million
   • Total Number of Shares Post-Issue: 10 million old shares + 2 million new shares = 12 million shares
   • TERP = $114 million / 12 million shares = $9.50

On the day the stock trades without the rights attached (known as going 'ex-rights'), its price should theoretically adjust from $10 down to $9.50 to reflect the new reality.

For a value investing practitioner, TERP is more than just a number; it's a starting point for deeper analysis.

TERP quantifies the immediate price dilution. Your $10 share is now theoretically worth $9.50. However, a savvy investor looks beyond this. The real question is about economic dilution. Is the company raising that $14 million to plug a hole in a sinking ship, or is it investing it in a project with a fantastic return on invested capital (ROIC)? If the new factory generates profits that eventually boost earnings per share, the initial dilution will be a distant memory. If the money is wasted, your stake in the business has been permanently devalued.

A rights issue is a moment of truth. Management is asking you, an owner, for more money. Why? Is it a sign of distress or a signal of a brilliant opportunity they can't fund otherwise? Calculating the TERP is part of the basic financial due diligence, but it should prompt you to re-read the company's reports and re-evaluate your investment thesis.

Occasionally, the market price on the ex-rights day will deviate significantly from the TERP. This can create short-term arbitrage opportunities for nimble traders. For the long-term value investor, however, this is mostly noise. Your focus should remain fixed on the intrinsic value of the business over the next five to ten years, not on a one-day price discrepancy.