The UniCredit case
The time has come: now it's up to Unicredit to make a capital increase, a 13 billion euro trinket. Obviously, so to speak: this is considered the largest capital increase in the history of Borsa Italiana, also because I would like to remind you that Unicredit, in addition to wanting to raise these 13 billion, has already accumulated other capital from the partial sale of Fineco (almost one billion) and from the sale of Pioneer (3,5 billion) and Bank Pekao (3 billion). Apart from the large numbers, let's take this opportunity to clarify how a capital increase takes place and why concepts such as "TERP" and "option rights" for shareholders are usually associated with this operation. These days in the trade press (but not only) you often read sentences like:
“…Unicredit lifts the veil on the conditions and price of the 13 billion euro capital increase. The discount on the theoretical price after the detachment of the option right is 38%…”
“… The disbursement for the new shares implies a discount of 38% compared to the price net of the detachment of rights (TERP), calculated on the basis of today's official price…”
Yes, I hate these hypertechnical messages too. To understand terms like “TERP” it is necessary to understand the mechanism of the capital increase.
there two types of capital increase:
1) free;
2) for a fee.
In the first case, the new capital does not come from outside but is found within the company itself (from reserves or profits from previous years); in the second case, however, the contribution of fresh money, i.e. cash, is required. Unicredit's is a paid capital increase.
The ingredients of a capital increase (for a fee)
A bank considered not very solid by the market and by regulators (in this case: Unicredit);
a lot of capital (but a lot, let's make 13 billion);
shareholders at will.
A "paid" capital increase consists in obtaining money from outside to place it in the bank that needs it; the capital is normally requested from the market and/or from the shareholders: the latter are the investors who already own Unicredit shares, perhaps for some time. In addition to the request to invest in the bank, these gentlemen are offered what is called an "option right", i.e. the right (not the obligation) to subscribe to the new shares - and therefore the capital increase - without diluting the own participation.
Dilution and option right
We know that each shareholder owns a certain percentage of the bank's capital – suppose a shareholder owns 3% of Unicredit's capital. At this point the capital increase takes place and, if our shareholder decides not to subscribe to it, his share will be reduced: in fact, despite holding the same number of shares, at the end of the recapitalization he will no longer have 3%, but a lower percentage, given that the total number of shares of the bank will increase.
This phenomenon is called shareholding dilution.
To prevent this from happening, the right of option is offered, a sort of "fast track"; a bit like when you book a restaurant for fear of remaining standing (that is, of not being able to buy your shares because they have been snapped up).
We have therefore explained why the option right exists. However, the latter also has a value on the market. To understand how much it is worth it is necessary to explain another obscure concept: the TERP.
What is TERP?
The TERP, in its down to earth definition (ie "earth", but I liked to say it in English) is simply the "average between two prices". It is used to know what the share price will be at the end of the entire capital increase operation. Calmly, now we get there.
Here is a small example:
Suppose a company has a total of 100 shares and the price is $11 per share. Things are not going very well for the company, which for this reason decides to issue another 1.000 shares at a price of 5 euros (capital increase against payment). We immediately notice that the new shares are issued at a lower value than those already issued in the past, why? Simple: to encourage purchase, also because if the newly issued shares cost more, it would be cheaper to buy those already issued.
Shareholder David currently owns 10 of the company's 100 shares (10% of the capital) and is wondering whether to subscribe to the capital increase. When the capital increase starts, the good David will also receive 10% rights, in our case 100 shares (because he previously held 10% of the capital) which will allow him to subscribe to another 100 new shares at a price of 5 euros each for no dilute its stake and consequently maintain 10% of the capital even after the increase. (We should be experts by now).
Well, at the end of the day, how much will the company's shares be worth? The TERP tells us so.
Calculate the TERP
The calculation is simple and requires only four ingredients:
the number of shares issued in the past (in our case it is 100);
the price of the shares already issued (in our case 11 euros);
the number of new shares that the company wants to issue (in our case 1.000);
the issue price of the new shares (in our case 5 euros).
Now we just have to make an average between 5 and 11 euros, however considering the number of shares (the weight). It is intuitive to think that since many more shares will be issued at €5, the final value will tend to approach €5 and will not be the exact average between €5 and €11. The “normal” average would have made sense if the company had issued a number of shares equal to the old one. Easy
Here is the TERP formula:
By replacing the numbers with the values we see that the result in this simple example is 5,54 euros.
Calculate the value of the option right
We have clarified what the TERP and the option right are. Of the latter, however, we have not explained how it is calculated. But now that we have introduced and calculated the TERP, calculating the option right is very simple: considering the example above, the value of the option right is given by the difference between the pre-capital increase share price and the TERP. In our example it will be 11-5,54 = 5,46 euros.
This is a theoretical value that does not always match reality. In fact, you need to know that this value is quoted on the market (just like shares or bonds) and the quoted value almost always differs from the theoretical one, especially over time.
Suppose that in the negotiation phase the right on the market is quoted above the equilibrium value of 5,46 euros: good David should sell the right and buy the share directly on the market. Conversely, if the right shares below the theoretical parity, the shareholder should keep (or even buy) the right and sell the shares on the market.
Are you a small UniCredit shareholder?
Surely reading this post will have clarified a few technical aspects, perhaps not intuitive, but of great importance for those approaching a capital increase. In another post, written some time ago, however, we addressed the issue of capital increases from the point of view of savers and citizens.
Source: AdviseOnly
