Lloyds Rights Issue: Price and Subsequent Share Price Predictions

The Lloyds rights issue price is to be announced in less than 9 hours, at 7am tomorrow (Tues 24th). I can barely contain my excitement!

Lloyds has been trading at between 90 and 91p today, the reference day for calculation of the theoretical ex-rights price (TERP):

Lloyds share price 23/11/09

I based my calculations on a share price of 90p which gave a TERP of ~55p and a rights issue price of ~33p. I’m pleased to see the Observer agrees, though I do worry who their “analysts” are. If they’ve merely found my blog (and it’s happened before) then their support is rather circular. I noticed, though, that Joseph Dickerson at Execution has been quoted as expecting “a rights in a 30-35p range”, which gives me rather more confidence that I haven’t done something silly.

I’m therefore going to stick my neck out and predict a rights issue price of 33.13p [see Note]. How do I arrive at this? Simple: it’s 3 rights for every 2 shares which is such a simple multiple that I expect Lloyds to be unable to resist it. Remember, we have to put in around 49.7p per share we currently hold. 2*49.7 is 99.4, divided by 3 is 33.13 to two decimal places.

What will happen to Lloyds share price then, though?

We’re coming up to the interesting part of the exercise, and I’ll be watching like a hawk.

My prediction is this:
1. Lloyds will start trading at 55p [see Note] immediately the market opens on Friday morning (when the rights are created and the shares go ex-rights).
2. The rights will start to fall from their value of 21.87p (55p – 33.13p) as some rights are sold in the market by those who simply do not have the cash to take up their entitlement.
3. The shares are dragged down, as arbitrageurs (hedge funds, say) buy rights and sell shares (or short the shares), knowing that they can exercise the rights and make a profit.
4. Other market participants with money to invest in Lloyds exploit the undervalued stock, and buy both the rights and the shares, pushing the shares back up towards 55p.

In other words, I expect supply and demand to depress Lloyds shares below the TERP over the fortnight or so before the rights issue closes. How far the shares fall is the proverbial million-dollar question. I doubt very much the shares will drop as far as 33p, but the natural depression of the price during a rights issue makes it very difficult to use this method of raising capital in a crisis, as we saw last year.

It’ll be very interesting to see how much the tendency of Lloyds shares to drop in price is counteracted by those who see the rights issue as a buying opportunity

I’ll be keeping an eye on things. Watch this space!

[Note (18:45 24/11): Lloyds have actually priced the rights issue at 37p, implying a “TERP” of ~60.24p. This is based on the closing price yesterday, 23rd, but the shares would be expected to start trading on 27th, when they go ex-rights, at a true TERP based on the closing price the previous day, 26th.

The reasons for the difference between the actual rights price and “TERP” and my estimates for these, above, are discussed in a Note to my previous post on this topic].