Lloyds Rights Issue: TERP turpitude?

I don’t believe this – another discrepancy!

Not only have Lloyds apparently managed to put a typo in their rights issue announcement and seem to have based their TERP calculation on the closing price of the shares yesterday and not their average price, they also seem to have calculated the TERP on the basis of raising £13.5bn and not the £13bn I used. Since the rights issue is costing the bank £500m (see Prospectus), my logic was that £500m has to be subtracted from the amount raised.

Lloyds claim:

“Discount of Issue Price to theoretical ex-rights price based on the Closing Price on 23 November 2009 ….. 38.6 per cent.”

We can reproduce their calculation, based on last night’s closing share price of 91.47p.

Total value of bank after rights issue/no. of shares after rights issue = £((0.9147 * 27,161,682,366) + 13,506,882,774)/(27,161,682,366 + 36,505,088,579)) = £(38351673634/63666770945) = ~60.238p.

Discount = (60.238 – 37)/60.238 = 38.58% i.e. the 38.6% stated.

But perhaps we should knock off the £500m cost of the rights issue:

Now we get a TERP of £(37851673634/63666770945) = 59.453p.

Discount = (59.453 – 37)/59.453 = 37.77%.

I presume the argument for doing the calculation the way Lloyds have is that the cost of the rights issue is in the share price already. The trouble is you could only really say this if you consider it 100% certain the rights issue will go ahead. To be fair, it’s probably not far off 100% since it’s very unlikely that the shareholders’ meeting on Thursday will vote down the rights issue. And if they did, this would in itself undermine the share price…

So perhaps the basis for the TERP calculation should be the price just before the rights issue was announced. But this would presume the rights issue was a complete surprise, which it wasn’t.

Then there are other aspects of the fund-raising that materially affect the share price: the £2.5bn fee to HMT to avoid the Asset Protection Scheme which was the alternative and the issue of “CoCos” that is part of the same restructuring exercise (and the success of which has given Lloyds shares a bit of a boost today).

So I suppose, on reflection, I will go along with the way Lloyds have done the TERP calculation and their figure of a 38.6% discount, based on last night’s closing price. The implication is that my original calculation of the rights issue price gave a figure that was slightly too low.

My main point is that it should be normal for rights issues to be heavily discounted. The share price of companies raising funds via rights issues can be volatile:

The difficulty in pinning down the share price that should be put into the calculation leads to a certain slipperiness in the basis for calculating the TERP – maybe the T for “theoretical” is the operative word – and suggests caution should be the name of the game in setting a rights issue price. But Lloyds is being very cautious.

Afterthought (13:45): The “slipperiness” is in calculating the TERP in advance. The TERP is only a valid measure once the rights issue is 100% certain to proceed. In the case of Lloyds we can only really say what the TERP and the rights issue discount to TERP is, based on Thursday’s closing price, just before the rights are created, and after the meeting to approve the rights issue. At this point everything is certain, and, in particular, the fees for the rights issue are committed, so the full amount raised by the rights issue should be included in the calculation (as Lloyds did it). So we (Lloyds, professional commentators and myself) are all mistaken in trying to determine a TERP until the rights issue is definite. At best the figures we’ve all been discussing are just (educated) guesses.