Rights Issue, TERP and a Cost-Limit Constraint
Nordwind AG has 120 million shares in issue at €12.40. It announces a fully underwritten 1-for-3 rights issue at €7.20 to fund a €300 million acquisition. The underwriting fee is 3.5% of gross proceeds. The company's largest shareholder, with 18%, has pre-committed to take up its rights but will not sub-underwrite. A hedge fund holds 2.4 million shares and is considering (a) taking up its rights, (b) selling the nil-paid rights, or (c) doing nothing. The fund's investment mandate permits a maximum 8% position in any issuer, measured at cost. Its average cost is €9.10 per share and its NAV is €320 million. The current bid price is €12.40; the theoretical ex-rights price is not yet reflected in the market. The fund has €5 million of cash available and a prime broker offering 4.5% margin financing.
1. Calculate the gross and net proceeds, the theoretical ex-rights price, the value of one nil-paid right, and the fund's position value under each of the three choices.
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Terms. New shares = 120m / 3 = 40m. Gross proceeds = 40m × €7.20 = €288m. Underwriting fee = 3.5% × €288m = €10.08m, so net proceeds = €277.92m, €22.08m short of the €300m acquisition cost unless the company uses cash or debt. (If the subscription price were €7.50, gross proceeds would be €300m and the fee €10.5m; the exam should use the stated €7.20.)
TERP. (3 × €12.40 + 1 × €7.20) / 4 = €44.40 / 4 = €11.10. Value of one nil-paid right = TERP − subscription price = €11.10 − €7.20 = €3.90.
Fund choices. The fund owns 2.4m shares and has an entitlement of 800,000 new shares (2.4m/3). (a) Take up: pay 800,000 × €7.20 = €5.76m; it has €5.0m cash, so it needs €0.76m of margin financing. Post-issue holding = 3.2m shares. Cost = existing 2.4m × €9.10 = €21.84m + €5.76m = €27.60m, which is 8.63% of €320m NAV, above the 8% cost limit. (b) Sell rights: receive 800,000 × €3.90 = €3.12m and keep 2.4m shares worth 2.4m × €11.10 = €26.64m; total €29.76m. (c) Do nothing: retain shares worth €26.64m and lose the €3.12m value.
2. Assess the dilution suffered by the fund if it does nothing, and explain why selling the rights should leave it economically neutral in theory.
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Doing nothing loses €3.12m relative to the pre-announcement value of 2.4m × €12.40 = €29.76m, a 10.48% reduction. The loss is not a market loss on the same number of shares; it is the value of the rights that the fund lets lapse, transferred to the underwriter or other subscribers. In theory, selling the rights recovers exactly that value: €26.64m of shares plus €3.12m cash = €29.76m, leaving the fund economically neutral before transaction costs and taxes. In practice, the nil-paid right may trade below theoretical value, and the fund may face liquidity or timing risk. The fund's voting stake also falls from 2.0% (2.4m/120m) to 1.5% (2.4m/160m), a control dilution that the cash calculation does not capture.
3. The underwriter proposes a clawback arrangement under which the largest shareholder can subscribe for any rights not taken up, at the subscription price. Discuss the regulatory and governance issues, including pre-emption rights and equal treatment.
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A clawback lets the largest shareholder subscribe for unexercised rights at €7.20. Pre-emption rights give existing shareholders the first right to new shares; a clawback is only permissible if the company has validly disapplied or modified pre-emption rights with the required shareholder approval and the prospectus discloses it. Equal treatment is the key test: the large holder must not receive terms unavailable to other shareholders, and the underwriter's fee and any sub-underwriting arrangements must be disclosed. The governance risk is a control shift: the holder starts at 18% (21.6m of 120m shares). If it takes its 4m entitlement and clawback absorbs enough of the 36m unsubscribed shares to reach 48m of the 160m post-issue shares, it crosses 30% and may trigger a mandatory bid under the applicable takeover code. The board should obtain a fairness opinion, disclose related-party aspects, and confirm the clawback is within the shareholder authority.