More warrants with novelty features set to surface

IN "CCM's piggyback warrant offers vision of the future" (BT Hock Lock Siew, Jan 23) we predicted that more companies would follow construction firm CCM and issue shareholders with free, unlisted warrants as part of a rights issue.

As it turns out, it hasn't taken long at all - less than a month later, investment holding company Cedar Strategic announced a fund-raising exercise not too dissimilar to CCM's - a placement of 1.27 billion new shares that comes with 1.27 billion free, unlisted warrants. The net $4.35 million raised from the share issue is to be used for real estate projects, which is Cedar's main business, but as many might ask - why unlisted warrants?

The answer is simple - if the warrants are issued in-the-money (ie, the exercise or conversion price is below the share price) or at-the-money (ie, the exercise price is very close to the share price), then any recovery in the shares that pushes the price above the exercise price will greatly increase the likelihood of conversion.

When this happens, the company receives a second round of cash which can be used to fund its business and hopefully effect a turnaround.

In CCM's case, its warrants carried an exercise price of one cent and were issued when the shares were around 2.5 cents. Since there is no market for these warrants, the logical course of action would have been to convert these into shares by paying the one cent (and then sell these shares for a quick profit), at which point CCM issued not just shares but a second round of free warrants that it called "piggyback" warrants.

These also carried a one cent conversion price, so again, there was a great incentive to convert, thus granting the company a second round of cash infusions (provided of course, that the shares stayed well above one cent).

Cedar's issue was similarly priced - the warrants carry an exercise price of 0.36 cent versus the shares at around 0.5 cent at the time so they were issued slightly in-the-money, but the latter has since fallen close to 0.36 cent so now they are at-the-money.

If fully exercised, as they should eventually be since they are unlisted and therefore have no market value, the company will receive an additional $4.6 million in gross proceeds - useful by any standards in its quest to improve its business.

Since it's likely that more companies will follow CCM and Cedar's example, it would be a good idea for retail investors to familiarise themselves with such issues as they possess novel features.

The first, of course, is that the warrants are not traded and are likely to be exercised as early as possible, something which appears completely at odds with conventional derivatives trading which holds that such instruments are better off traded than exercised.

This seemingly anomalous state of affairs is easily explained when one considers that although warrants like CCM's and Cedar's derive their value from the underlying shares, they differ from typical derivatives in that they offer very little leverage, having been designed not as instruments to be traded but solely with the aim of forcing holders to exercise early. So even if they were traded, the lack of leverage implies that early exercise would probably be preferable.

Second, a rights/bonus issue of this sort works well if launched when shares are at record lows, as was the case with CCM and Cedar. This is in stark contrast to accepted practice, which is to call for a rights issue when the shares have risen sharply so as to maximise the cash received.

Third, it looks like attaching warrants as sweeteners to make a rights issue as attractive as possible is gaining in popularity. Myanmar coal and cement play WE Holdings, for example, last month proposed a renounceable, non-underwritten share-cum-warrants rights issue in which the latter will have an exercise price of three cents and will be listed.

Early exercise of WE's warrants is unlikely since the shares trade around 2.5 cents but once the money raised from the share issue is deployed, and if the shares start to run up thereafter, it'll be interesting to see if warrant holders convert their holdings or will be happy just to trade their warrants.

Fourth, all these exercises suggest that the local corporate sector and its advisers have devised clever and attractive strategies to raise capital, even for companies whose shares have crashed to just a few cents, by attaching either listed or unlisted warrants. And why not? These companies, like any other, have a perfectly legitimate right to raise funds in any manner that is within the rules, and if the means chosen also give shareholders the chance to turn a quick profit, all the better.

Critics might bemoan the dilution wrought by the issue of hundreds of millions of new shares, but the fact remains that virtually all forms of fund raising are either dilutive or otherwise arguably detrimental to shareholders - raising funds through borrowing, for example, increases interest cost, gearing and hits the bottom line.

Moreover, these are companies whose shares have already crashed to close to all-time lows, so any dilutive and adverse effects on the share price can arguably only be minimal. Finally, with the extra cash, there is at least some chance of returning to profitability, so ultimately, shareholders could benefit.

Since there are hundreds of penny stocks in the local market, it's likely that we'll see more of such share-cum-warrant issues, with the latter either untraded or traded. Stay tuned.