TERP stands for Theoretical Ex-Rights Price, which is the anticipated market price of a stock after a rights offering has been completed. A rights offering gives existing shareholders the opportunity to purchase additional shares of the company, usually at a discounted price.
Here's a more detailed breakdown:
Understanding Rights Offerings
- What are Rights? Rights are essentially privileges given to existing shareholders to buy new shares of a company before they are offered to the public.
- Purpose: Companies use rights offerings to raise capital.
- Impact on Stock Price: Introducing new shares to the market generally dilutes the value of existing shares. The TERP helps investors estimate what the new share price will be after this dilution.
How TERP is Calculated
The formula for calculating TERP is:
TERP = ( (Original Share Price x Number of Existing Shares) + (Subscription Price x Number of New Shares) ) / (Total Number of Shares After Rights Issue)
Let's break down each component:
- Original Share Price: The market price of the stock before the rights offering.
- Number of Existing Shares: The total number of outstanding shares before the rights issue.
- Subscription Price: The price at which existing shareholders can purchase new shares through the rights offering. This is typically lower than the current market price.
- Number of New Shares: The number of new shares being issued through the rights offering.
- Total Number of Shares After Rights Issue: The sum of the original shares and the new shares issued.
Example
Suppose a company has:
- 1,000,000 existing shares trading at \$10.00 (Original Share Price)
- A rights offering that allows shareholders to buy 1 new share for every 5 shares they already own (Number of New Shares = 1,000,000 / 5 = 200,000 new shares)
- The subscription price for the new shares is \$8.00 (Subscription Price)
Then:
- Total Number of Shares After Rights Issue = 1,000,000 + 200,000 = 1,200,000
TERP = ( (\$10.00 x 1,000,000) + (\$8.00 x 200,000) ) / 1,200,000
TERP = ( \$10,000,000 + \$1,600,000 ) / 1,200,000
TERP = \$11,600,000 / 1,200,000
TERP = \$9.67 (approximately)
Therefore, the theoretical ex-rights price would be around \$9.67 per share.
Why is TERP Important?
- Informed Decisions: Helps shareholders decide whether to exercise their rights (buy new shares) or sell them.
- Price Expectation: Provides an estimate of the stock's likely price after the rights offering, helping to manage expectations.
- Arbitrage Opportunities: Traders may use TERP to identify potential arbitrage opportunities between the rights and the underlying stock.
In summary, TERP is a critical metric for understanding the impact of a rights offering on a stock's price and helps investors make informed decisions about participating in the offering.
