Modeling Rights Offering Arbitrage

Modeling Rights Offering Arbitrage

When To Use

• Issuer announces a rights offering and you need to model the theoretical ex-rights price (TERP) to evaluate fair value impact
• Evaluating whether nil-paid rights are mispriced relative to the subscription price and cum-rights share price
• Sizing an arbitrage position by comparing the market price of nil-paid rights to their theoretical value
• Assessing dilution impact on existing shareholders who do not exercise
• Analyzing an activist's strategy where a rights offering is used as a defensive or offensive capital structure tool
• Modeling oversubscription privilege economics and backstop commitment fees

Inputs To Gather

• Cum-rights share price — last traded price before the ex-rights date (or current price if pre-ex-date)
• Subscription price — the price at which new shares can be purchased under the offering
• Rights ratio — number of existing shares required to subscribe for one new share (e.g., 4:1 means 4 old shares yield 1 right to buy 1 new share)
• Total shares outstanding (pre-offering) and new shares to be issued
• Gross offering proceeds and any backstop/standby fees
• Key dates — record date, ex-rights date, subscription period, oversubscription deadline, closing date
• Oversubscription terms — whether oversubscription privilege exists, any pro-rata allocation mechanics
• Market data — nil-paid rights trading price (if rights are renounceable and listed), sector comps, short borrow availability
• Issuer-specific context — reason for offering (deleveraging, acquisition financing, regulatory capital), any concurrent transactions

Workflow

1. Calculate TERP

   • TERP = (Cum-rights price × Existing shares + Subscription price × New shares) / (Existing shares + New shares)
   • Express TERP discount to cum-rights price as a percentage

2. Derive theoretical nil-paid rights value

   • Theoretical value per right = (Cum-rights price − Subscription price) / (Rights ratio + 1)
   • Alternative: TERP − Subscription price (value of one right when one right is needed per new share)
   • Confirm which formula applies based on the specific rights ratio structure

3. Assess subscription premium / discount

   • Compare the subscription price to TERP — a deeper discount incentivizes take-up
   • Flag if discount is unusually shallow (<10%) as this increases non-exercise risk and rights value volatility

4. Model arbitrage P&L scenarios

   • Fully hedged arbitrage: Buy nil-paid rights, subscribe for shares, short sell equivalent shares at TERP or market price; P&L = market price of rights vs. theoretical value minus borrow cost, execution slippage, and fees
   • Unhedged participation: Subscribe and hold — model upside/downside to TERP under bull/bear share price scenarios
   • Rights sale: Sell nil-paid rights in the market — compare to theoretical value and factor in liquidity discount

5. Run dilution and ownership analysis

   • Model post-offering ownership for participating vs. non-participating shareholders
   • Calculate wealth transfer from non-exercising to exercising shareholders
   • If an activist holds a disclosed stake, model their post-offering ownership under full exercise, partial exercise, and oversubscription scenarios

6. Sensitivity analysis

   • Vary cum-rights share price (±5%, ±10%, ±20%) and recalculate TERP, nil-paid value, and arbitrage P&L
   • Vary take-up rate (70%, 85%, 100%) to assess oversubscription allocation and backstop exposure
   • Stress-test borrow cost assumptions for the short leg of the hedge

7. Timeline and execution risk

   • Map key dates to identify the subscription window and settlement lag
   • Flag jurisdictional restrictions on rights trading or short selling [VERIFY]
   • Note any regulatory approvals required before closing (e.g., antitrust, banking regulator capital approval) [VERIFY]

Output

• TERP summary table: Cum-rights price, subscription price, rights ratio, TERP, TERP discount %, theoretical nil-paid value
• Arbitrage P&L matrix: Scenarios across share price movements and take-up rates, showing gross and net P&L per share/right
• Dilution waterfall: Pre- and post-offering share counts, ownership percentages for key holders, and wealth transfer to/from non-exercisers
• Key dates timeline: Record date through settlement, with trading windows for nil-paid rights
• Risk flags: Liquidity of nil-paid rights market, borrow availability for hedging, regulatory or jurisdictional constraints, backstop counterparty risk

Quality Checks

• Confirm TERP is between the subscription price and cum-rights price — if not, recheck inputs
• Verify nil-paid rights value is positive; a negative value implies subscription price exceeds cum-rights price (a deeply distressed scenario requiring separate analysis)
• Cross-check total offering proceeds = subscription price × new shares issued
• Ensure dilution math reconciles: new shares / (existing + new) = dilution percentage
• Validate that arbitrage P&L accounts for all friction costs (borrow, commissions, FX if cross-listed)
• If nil-paid rights are trading, compare theoretical value to market price and explain any material divergence (liquidity premium, time value, hedging demand)
• Mark any jurisdiction-specific tax treatment of rights (e.g., CGT treatment of nil-paid rights sales) with [VERIFY]