Rights Issues Explained: TERP, Subscription Rights and Dilution

A company offers existing shareholders new stock at 12 when its shares trade cum-rights at 20. The 40% discount is not a 40% investment return. New shares enlarge the denominator, existing shares lose the attached entitlement, and subscribing requires fresh cash.

The useful comparison is between taking up the offer, selling a transferable entitlement and allowing it to lapse. Keep both wealth and ownership in view. The example below is hypothetical, uses one currency and assumes a fully subscribed issue of identical ordinary shares, no costs or taxes, and no change in the value of the underlying business.

Calculate the ex-rights benchmark before reading the discount

You own 1,000 shares worth 20 each, a holding of 20,000. A one-for-four issue at 12 gives you the opportunity to buy 250 new shares for an additional 3,000. Take a block of four existing shares: their value is 80. Add 12 of new cash and divide the combined 92 by five shares.

Theoretical ex-rights price, or TERP = (4 × 20 + 12) / 5 = 18.4. This treats each unit of subscription cash as one unit of additional equity value. It gives the proposed investment no extra value and deducts no issuance expenses. It is a comparison benchmark, not a forecast of the opening price.

The offer is 40% below the cum-rights price but about 34.78% below TERP. Neither percentage is your gain. A subscriber pays cash and uses an entitlement that has economic value; the new shares are not bought in isolation from the old holding.

Three choices, with the cash included

Define the units carefully. In this example, each old share receives one right, and four rights plus 12 buy one new share. One right is theoretically worth 20 − 18.4 = 1.6. Your 1,000 rights therefore have a combined theoretical value of 1,600.

A shareholding of 23,000 after subscribing is not a profit of 3,000: you supplied that cash. The last column puts the choices on a common starting-capital basis. It is neither a tax-cost calculation nor an annualized return that adjusts for different cash-flow dates.

The sale case requires transferable rights and an actual buyer. Selling for 1,600 with total costs of 100 leaves a comparison value of 19,900. If the executable rights price is only 1.2, proceeds are 1,200 and the value is 19,600 before costs, holding the other assumptions fixed. An entitlement is not a guaranteed cash payment from the issuer.

A right worth 1.6 or 6.4? Check what one unit buys

Four of our rights are worth 6.4; adding the subscription payment of 12 gives a new share worth 18.4 in the model. Some offer documents or trading conventions instead describe one entitlement as the complete ability to subscribe for one new share. Its corresponding value here is 6.4, not 1.6.

Confusing these units can create a fourfold error in rights value, share quantity or funding needs. Write down the old shares held, the rights allocated, the new shares obtainable per right and the cash payable per new share. A one-for-four offer is not four new shares for each old share. The rights security and the ordinary share may also use different trading codes.

If the stock subsequently trades below 12, the attractive-discount conclusion based on an old price of 20 no longer holds. Rights may have no immediate exercise value, although a pre-expiry market price can still reflect time, volatility and offer terms. The static calculation is not proof of an executable, risk-free arbitrage.

Preserving wealth does not preserve your voting percentage

Suppose the company has 1 million shares before the offer and 1.25 million afterwards. Your original 1,000 shares represent 0.1%. Without subscribing, they become 0.08%, a 20% relative reduction. Taking up 250 shares restores the 0.1% stake. This assumes full subscription and no other capital changes.

A rights sale at theoretical value can preserve modeled wealth while leaving the ownership dilution intact. Equally, paying more cash to maintain your percentage does not prove the new investment is attractive. The use of proceeds, financing pressure, issuance costs and the expected return on that capital still matter.

Cash direction is crucial. A cash dividend in total shareholder return moves money out of the company. A rights subscription moves money into it. Counting all the new shares as a gain while ignoring the debit from your cash account reverses the economics.

The chart gap is not the whole return

A move from 20 to 18.4 is an 8% gap on an unadjusted price series. If valuable rights accompany the holding, reading only the ordinary-share price misses an asset. But if rights expire unused without compensation, calling the loss “just an adjustment” does not restore that value. An adjusted chart cannot replace a ledger of subscriptions, rights proceeds, fees and delivered shares.

Actual prices also reflect business news, offer completion risk and the market's assessment of the money being raised. Different dividend entitlements, attached warrants or another class of security can invalidate the simple ordinary-share formula. Non-transferable entitlements cannot be sold using the second row of the table. Any disposal arrangement or compensation for unexercised rights depends on the specific offer.

The ex-date, record date, last rights-trading date, subscription deadline and first trading day for new shares serve different purposes. A broker can require instructions earlier. Receiving rights or sending an instruction is not confirmation that payment cleared, the application was accepted or the new stock is available to sell.

Turn the announcement into five checkable records

1. Eligibility: establish the record and ex-date arrangements, jurisdictional restrictions, transferability and fractional-entitlement treatment.
2. Units: calculate rights, new shares and cash from your own holding rather than copying the headline discount.
3. Cash by route: include subscription payments, net sale proceeds, taxes, conversion and funding costs. Keep theoretical values separate from executable prices.
4. Wealth and control: reconcile enlarged share capital, assess the use of funds and check offer conditions. Maintaining a percentage is not itself an investment return.
5. Execution: record every deadline and allocation status, reconcile the result after completion and recalculate if terms, prices or the issue size change.

A discount says how one price compares with another. It does not measure wealth created. The decision becomes clearer only when old shares, rights, new shares and cash sit in the same calculation—and eligibility, funding and timing make the chosen route genuinely available.