What it means
The mechanics start with a ratio and a price. A company might announce a one-for-four offer at a discount, meaning every shareholder may buy one new share for every four they already hold, at a price set below where the shares are currently trading.
The discount is not a gift, which surprises many first-time participants. Issuing new shares cheaply dilutes the value of every existing share, so the theoretical price after the offer settles between the old market price and the offer price, and shareholders who take up their entitlement end up roughly where they started.
That settling point has a name: the theoretical ex-rights price, or TERP. It is the weighted average of the old shares at the market price and the new shares at the offer price, and it is the reference point brokers use to judge whether the offer is being received well or badly.
Entitlement offers come in two main forms. In a renounceable offer, shareholders who do not want to participate can sell their entitlements to someone else and recover some value, while in a non-renounceable offer the entitlement simply lapses and those shareholders are diluted with no compensation.
Companies also split offers into an institutional and a retail component to raise money quickly. The institutional part typically completes within days, giving the company certainty, while retail shareholders receive an offer document and have several weeks to decide.
The reason for the raise matters more than the discount. A company raising money to fund a clearly profitable expansion is a very different proposition from one raising money to repay debt it cannot service, even if the two offers look identical on the term sheet.
In practice
Real-world examples.
Example
A retailer needs $80,000,000 to buy out its franchise partners and announces a one-for-four entitlement offer at a 20% discount. Its two largest shareholders commit to taking up their full entitlements in advance, which reassures the market that the raise will succeed.
Example
A mining company runs a renounceable offer, and a shareholder who cannot afford to participate sells her entitlements on the market for $1.45 each. She is diluted but recovers most of the value the discount would otherwise have transferred away from her.
Example
A property trust announces a deeply discounted non-renounceable offer to repay maturing debt. Retail holders who ignore the mailing are diluted heavily, and the trust later faces criticism for choosing a structure that gave non-participants no way to recover value.
Formula
Calculation
Theoretical ex-rights price = (number of existing shares x market price + number of new shares x offer price) / total shares after the offer
Value of one entitlement = theoretical ex-rights price - offer price
Worked example. A company announces a one-for-four entitlement offer at $8.00 per new share. The shares currently trade at $10.00.
Take a holding of 4 existing shares, which gives the right to buy 1 new share.
Value of existing shares = 4 x $10.00 = $40.00
Cost of the new share = 1 x $8.00 = $8.00
Total value = $40.00 + $8.00 = $48.00
Total shares held afterwards = 4 + 1 = 5
Theoretical ex-rights price = $48.00 / 5 = $9.60
Value of one entitlement = $9.60 - $8.00 = $1.60
A shareholder who takes up the offer pays $8.00 for a share theoretically worth $9.60, and their overall position is unchanged because their original four shares have fallen from $10.00 to $9.60 each. A shareholder who does nothing under a non-renounceable offer simply sees their four shares drop from $40.00 to 4 x $9.60 = $38.40, a loss of $1.60. If the company has 40,000,000 shares in issue, it will issue 40,000,000 / 4 = 10,000,000 new shares and raise 10,000,000 x $8.00 = $80,000,000 before costs.Case study
Seen in the real world.
Marlow Rail Components is an illustrative, entirely fictional listed engineering business with 40,000,000 shares trading at $10.00. It won a long-term supply contract that required a new machining facility costing $80,000,000, more than its balance sheet could support through borrowing alone.
The board chose a one-for-four renounceable entitlement offer at $8.00 per share, raising 10,000,000 x $8.00 = $80,000,000 before costs. Advisers calculated a theoretical ex-rights price of $9.60 and explained to the board that shareholders who participated would be no worse off, while those who sold their entitlements should recover about $1.60 per entitlement in the market.
The illustrative result was a 94% take-up among institutions and 71% among retail holders, with the remaining entitlements sold in a shortfall bookbuild at $1.72 each and the proceeds returned to non-participating shareholders. The chair's letter afterwards made the point that choosing a renounceable structure had cost slightly more to administer but had avoided the accusation, common in such raises, that small shareholders were quietly penalised for not reading their post.
Watch out
Common mistakes.
- Seeing the discount as free money, when the share price falls to the theoretical ex-rights price and participating shareholders simply maintain the value they already had.
- Ignoring the offer documents under a non-renounceable structure, which means the entitlement lapses worthless and the holding is diluted with nothing received in return.
- Judging the offer only on the size of the discount rather than on what the money will be used for, which is what actually determines whether the shares are worth more afterwards.
Questions
People also ask.
What is the difference between a renounceable and a non-renounceable offer?
In a renounceable offer you can sell your entitlement to someone else for cash, whereas in a non-renounceable offer it lapses and you receive nothing if you do not take it up.
Why do companies price the offer at a discount?
The discount compensates shareholders for the money they must commit and reduces the risk that the share price falls below the offer price before the deadline, which would leave the raise unfinished.
Does taking up my entitlement protect me from dilution?
Taking up your full entitlement keeps your percentage ownership unchanged, which is the main reason to participate even when you would not otherwise buy more shares.
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