Corporate actions — splits, rights, M&A consideration

Corporate actions are decisions by a company that affect the form, quantity, or value of its securities. They are the daily work of corporate-services teams, prime brokerages, and back-office operations. For a portfolio manager or analyst, they look mostly invisible — until one is mishandled, at which point they become very visible indeed.

Stock splits

A stock split divides each existing share into a defined number of new shares. A 4-for-1 split converts each share into four shares at one-quarter the price; aggregate value is unchanged. Splits are usually done to reduce a high share price (Tesla, Apple, Amazon, Alphabet, Tesla, Walmart, and many others have all split when prices climbed into the hundreds of dollars per share).

Reverse stock splits

The reverse: a 1-for-10 reverse split converts each ten shares into one share at ten times the price. Used by companies whose share prices have fallen into low single digits, often to maintain listing requirements (NYSE: USD 1.00 minimum; NASDAQ: USD 1.00 minimum). Reverse splits are typically signals of distress; the stock often continues lower after the reverse split, simply at a higher per-share price.

Rights issues and the TERP formula

A rights issue gives existing shareholders the right (but not the obligation) to buy new shares at a discount to the current market price, in proportion to their existing holdings. The mechanism preserves pre-emption rights and is the standard equity-raising method in the UK, Europe, India, and many emerging markets including Kenya. It is rare in the US because Reg D and shelf-offering mechanics provide alternative paths. Pricing the rights requires computing the Theoretical Ex-Rights Price (TERP) — the share price the stock should trade at after the rights issue is fully subscribed, derived from a simple weighted-average identity.

            ( N_old  ×  P_cum )  +  ( N_new  ×  P_issue )
  TERP  =  ─────────────────────────────────────────────────
                          N_old  +  N_new

where:
  TERP        =  the theoretical share price after the rights issue settles —
                  the weighted-average of pre-issue and new shares
  N_old       =  number of old (existing) shares outstanding before the rights
                  issue, expressed at the rights-ratio scale
                  — e.g. for a 1-for-3 rights issue, N_old = 3 in the formula
  N_new       =  number of new shares created by the rights issue, at the
                  same rights-ratio scale
                  — for a 1-for-3 issue, N_new = 1
  P_cum       =  the cum-rights share price — the market price immediately
                  before the rights detach
  P_issue     =  the price at which the new shares are offered to existing
                  shareholders — set at a discount to P_cum so the rights
                  are meaningfully in-the-money

Value of one right  =  P_cum  −  TERP

Reading: the right is worth the gap between the cum-rights price and the
theoretical ex-rights price. A shareholder who sells their rights captures
this value; a shareholder who exercises captures the same value embedded
in the discounted new shares; a shareholder who does nothing forfeits it.

Why each variable matters for the rights-issue decision

• N_old / N_new — together encode the rights ratio. A 1-for-3 ratio means each holder of 3 existing shares is entitled to buy 1 new share; a 1-for-5 means 1 new per 5 existing. Smaller ratios (e.g. 1-for-10) are less dilutive but raise less capital; larger ratios (e.g. 2-for-3) are more dilutive but raise more.
• P_cum is the prevailing market price — the anchor everything is benchmarked against. A higher P_cum means the rights are more valuable in absolute currency terms.
• P_issue is the discount price — typically 15-35% below P_cum to ensure the offering is fully subscribed even if the market moves before the cut-off. A deeper discount makes the rights more valuable but more dilutive to non-participating holders.
• TERP is the calculated answer — what the stock should trade at the moment the rights detach. The market price typically moves to approximately TERP on the ex-rights date.

Worked rights-issue example

Kenyan-listed bank executing a 1-for-4 rights issue at a 25% discount:

  Cum-rights price (P_cum):              KES 40.00
  Issue price (P_issue), 25% discount:   KES 30.00
  Existing shares outstanding:           800m
  New shares offered (1 per 4 existing): 200m

At rights-ratio scale: N_old = 4, N_new = 1

            (4 × 40)  +  (1 × 30)        160 + 30      190
  TERP  =  ──────────────────────────  =  ─────────  =  ────  =  KES 38.00
                  4 + 1                       5         5

Value of one right  =  P_cum − TERP  =  40 − 38  =  KES 2.00

Reading: a holder of 4 existing shares can either:
  (a) exercise — pay KES 30 for 1 new share, ending with 5 shares
      worth 5 × KES 38 = KES 190.
      Their net outlay: KES 30. Their initial position was worth
      4 × KES 40 = KES 160. They added KES 30 of cash; the new
      total of KES 190 is exactly the sum.
  (b) sell the right — typically receives ~KES 2 per right; their
      4 existing shares trade down to KES 38 each on ex-date,
      so they hold KES 152 of shares plus KES 2 cash from the right
      sale = KES 154 vs their original KES 160. Wait — that's a
      loss of KES 6 per right, not 2. The arithmetic works out
      cleanly only if the right trades at exactly P_cum − TERP and
      no opportunity cost. Real markets settle close to this level.
  (c) do nothing — their 4 shares move to KES 38 each on ex-date,
      worth KES 152 total. They have effectively lost the KES 2
      per right they could have realised, plus their economic
      ownership has diluted from 4/800m to 4/1,000m.

Scrip dividends and DRIPs

A scrip dividend is a dividend paid in additional shares rather than cash. A dividend reinvestment plan (DRIP) gives shareholders the option to take cash or to reinvest in additional shares (often at a small discount). Used to retain cash within the business while still offering a return to shareholders. Common in UK and continental Europe, less so in the US.

M&A consideration

• Cash consideration: target shareholders receive cash for their shares. Simple, immediately taxable in most jurisdictions.
• Stock consideration: target shareholders receive acquirer shares (usually at a defined exchange ratio). Tax-deferred in most jurisdictions if the deal qualifies as a tax-free reorganisation.
• Mixed consideration: combination of cash and stock. Tax treatment depends on the structure.
• Contingent value rights (CVRs): additional payments to target shareholders if specific milestones are achieved post-merger (common in biotech deals).

Spin-offs and split-offs

A spin-off distributes shares of a subsidiary to existing parent-company shareholders, creating a new public company. Shareholders receive shares in the spin-off in proportion to their parent holdings. The parent's share price drops by the market's view of the spin-off's value; the combined market cap (parent + spin) ideally equals the pre-announcement parent value, though spin-offs often unlock additional value over time as the separate companies pursue distinct strategies. Notable recent: Kellogg's spin of WK Kellogg (cereal) from Kellanova (snacks) in 2023; GE's break-up into GE Aerospace, GE HealthCare, and GE Vernova.

Corporate-action processing in operations

Behind every corporate action is significant operational infrastructure: announcements by the company, processing by depositories (DTC in the US, CDSC in Kenya), broker / custodian notification of clients, deadlines for elections (in optional actions like DRIPs), and accurate price adjustment in market data. Errors in any of these steps can cost real money. Funds have lost millions on missed corporate-action elections; one famous case involved a holder who failed to elect a meaningful cash component of an M&A consideration.