Tuesday, 25 September 2012

What is TERP and how do you calculate it?

In previous posts on equity raisings I have said that you can make significant profits from equity raisings if you manage to invest at a significant discount to TERP.  In this post I will define what TERP is and how you can calculate it yourself.

What is TERP?

TERP is the Theoretical Ex-Rights Price of a share after an equity raising.  It is the price the share should trade at, all else remaining constant, after a company has completed an equity raising - it accounts for the number of new shares received as well as the increased cash in the business.

Why is TERP an important number?

You should always calculate TERP because it will tell you what sort of deal you are getting with an equity raising (or conversely how much you are losing by not participating in the equity raising).  The bigger the discount to TERP the more you lose by staying out of an equity raising or the more you have to gain if you participate above your original entitlement.

How do you calculate TERP?

The TERP calculation is pretty simple.  Instead of memorising a formula though - I find the easiest way to make sure you are doing the right thing is to remember all those things that are impacting the value of the company.  What you need to calculate TERP therefore is
  • The pre-equity raising share price
  • The pre-equity raising shares outstanding
  • The price the new shares are being issued at
  • The new shares to be issued
Thinking about TERP conceptually what you are doing is:
  1. Taking the original market capitalisation of the company
  2. Adding on the cash received during the equity offering to give you your new market capitalisation
  3. Then divide by your new shares outstanding
  4. This will give you your Theoretical Ex Rights Price
The above converted into a formula is:

[(Pre-Equity Raising Price x Pre Raising Shares) + (Rights price x New Shares issued)] / [Pre-Raising Shares + New Shares issued]

A simplified version of this is:

(Pre-equity raising market cap + Cash raised) / Total shares outstanding after equity raise

Things to remember about TERP

There are several things that you should remember about TERP including
  • It is a theoretical value ONLY
    • You can almost guarantee that the shares will not trade at this price however it is the best proxy you have for what the shares will trade at post an equity offering which is why people use it
    • TERP is a point in time estimate.  The market will move while the equity offering is underway and there is the very real possibility that the shares will trade well below TERP.
  • While a deal can look good on a TERP basis it may not be in real life
    • This once again is due to the theoretical nature of TERP - I can't emphasise enough that you need to keep this point in mind
  • Shares often trade above TERP post an equity raising
    • Often shares are depressed prior to an equity raising because the market knows or suspects that the company will need to raise equity
    • Once this has happened and the risk is removed the shares trade back at a 'normal' value and the post equity raise shares trade above TERP
You May Also be Interested In:
Bad corporate governance may cost YOU money in equity raises
Rights issues: Reading the fine print can make you thousands
Making money from share purchase plans
Share purchase plans - when things don't go to plan

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