Uncharted Territory

December 7, 2009

Lloyds Rights Issue: the Story So Far

Filed under: Economics, Lloyds, Rights issues — Tim Joslin @ 12:11 pm

So good: Lloyds has clearly pitched its rights price – 37p – sufficiently low for the rights issue to succeed. The rights have significant value (around 17p just now) that someone will buy them. Even if shareholders do nothing, the rights (or the shares they represent) will be sold in the market at the end of the process.

Nevertheless, I’d argue that the rights issue itself has had a significant effect on Lloyds’ share price.

I wrote a couple of weeks ago that the theoretical ex-rights price (TERP) can only be calculated based on the closing price before the shares go ex-rights. It is only at this point that the rights issue becomes close to a mathematical exercise. Nevertheless, news-flow will continue to affect the share price.

Lloyds in fact closed at 88.83p on 26th November, compared to the 91.47p closing price on the 23rd that Lloyds used for calculating the discount of the rights issue price to the share price.

Following the same method used previously (but ignoring the non-voting share complication):
(total value of Lloyds after rights issue)/(no. of shares after rights issue) = £((0.8883 * 27,161,682,366) + 13,506,882,774)/(27,161,682,366 + 36,505,088,579)) = £(37634605219/63666770945) = ~59.11p.

The rights price (37p) is therefore at a discount of (59.11 – 37)/59.11 = ~37.4% and nil-paid rights should trade at 22.11p.

The question I’m interested in is how much the rights issue has depressed the Lloyds share price.

It’s worth noting first that the rights price and the share price move in lockstep:

Lloyds rights price 30/11 to 4/12

Lloyds share price 30/11 to 4/12

The only thing that is keeping these prices so closely in step is the behaviour of market participants. Profit-making opportunities arise if the prices of the shares and the rights move out of alignment. It’s a simple “wisdom of crowds” effect.

The above graphs also show that the rights and shares have both traded consistently below the prices implied by the TERP.

The problem is that it is very difficult to separate the effect of the rights issue from the effect of news-flow. And we’ve had a lot of news: the Dubai saga, Bank of America repaying government funds and no end of speculation about the UK’s upcoming pre-budget report (PBR) which could all affect the Lloyds share price. On the other hand, the UK Supreme Court ruling that customers (aka the Office of Fair Trading) could not retrospectively challenge fees and news of the emergency loan to HBoS unbelievably kept secret during Lloyds’ takeover should have been in the share price, as these stories broke during the week leading up to the rights issue.

Nevertheless, only briefly on the first morning of the rights issue did the shares and rights trade above the TERP:

Lloyds share price 27/11

To determine whether the increased supply of Lloyds shares or news-flow because of the rights issue has affected the price, we could try comparing Lloyds price with that of other UK banks:

Lloyds share price vs RBoS' 27/11 to 4/12

Lloyds share price vs Barclays' 27/11 to 4/12

Lloyds, RBoS and Barclays are quite different businesses, but maybe we can tentatively conclude that the rights issue has caused Lloyds share price to fall relative to its peers.

But it could be worse than this. Some shareholders may have sold shares in other banks in order to take part in the Lloyds rights issue. They may be rebalancing their portfolios, whilst keeping the proportion of UK banks the same (i.e. selling some holdings in other banks to raise funds to participate in the rights issue at least for some of their entitlement, thereby keeping their holdings in the same proportions as previously to the total market values of the banks), or they may consider that Lloyds’ share price would be depressed by the rights issue.

More than that, some shareholders may have sold Lloyds shares in advance of the rights issue in order to participate. They may have tried to pre-empt the drop in Lloyds’ share price close to the rights issue.

A final comparison that may therefore be useful is Lloyds’ share price against the FTSE-100 index over the last 3 months:

Lloyds vs FTSE last 3 months

You could choose to attribute the >10% fall in Lloyds’ share price against the FTSE to the upcoming rights issue.

The problem we face is that it is impossible to be sure why people have sold shares. Financial columnists rationalise share price movements, but this is just opinion. The price may have fallen on a particular day because of fears over Dubai, for example, but it may have fallen because more shareholders wanted the money than the shares. Or both.

All we know is that there was an equilibrium between buyers and sellers of Lloyds’ shares (and rights) at a share price of 88.83p last Thursday (equivalent to 59.11p) and 54.28p right now.

It’s a question of judgement whether 59.11p, 54.28p or some other figure truly represents the long-run value of Lloyds’ shares.

Personally, I’d certainly argue that Lloyds’ share price is depressed by the rights issue. It follows that if I don’t participate in the rights issue, I have to accept that depressed share price for my rights. That’s why it seems to me that the best thing to do is to subscribe to the rights issue, even if I intend to sell the shares in a few months time.

Note that if you do nothing, the rights will be sold for you in the market and you will receive the funds raised.

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