Sunday 10 September 2017

The Small Cushion That Warrants Provide

I have a small, speculative strategy affectionately called the "minion strategy", which involves throwing a small amount of money into certain depressed stocks that have the potential for a turnaround. The money is mentally written off the moment it is invested. The strategy is described in more details in Meet The Minions. Since the money will be written off anyway, if the stock has a warrant, I would choose the warrant over the mother share, as warrants are cheaper and rise (or fall) proportionally more than the mother shares. 

One of the recently added minions is Ezion warrant. As luck would have it, on the day I bought the warrant, Ezion called for a trading halt (later changed to a suspension). I literally had to write off the amount the moment it was invested. Later announcements by the company mentioned that it was in discussion with lenders to secure additional funds for working capital. On some investor forums, there were comments that Ezion might need to call a rights issue again to raise funds.  

When a company calls a rights issue, shareholders either have to cough up more money to subscribe to additional shares, or sell the rights (if the rights are renounceable) to collect some money back. Because a rights issue dilutes the amount of shares a warrant can be converted into, there are adjustments made to the conversion terms of the warrants. For example, each Ezion warrant is currently convertible into 1 Ezion share at an exercise price of $0.45. If Ezion were to call a rights issue and increase the no. of shares outstanding, the shares that warrant holders get would be worth less if the conversion ratio and the exercise price stay the same. Hence, there is an adjustment to the conversion ratio and/or exercise price. 

The Ezion warrants were issued in Apr 2016 as bonus warrants to all shareholders. Each warrant was then convertible to 1 share at an exercise price of $0.50. In Jun 2016, Ezion called a 3-for-10 rights issue at an issue price of $0.29. Adjustments were made to the warrants such that holders got 0.113 free warrants for every existing warrant (in lieu of changing the conversion ratio of 1 share for every 1 warrant). In addition, the exercise price was adjusted from $0.50 to $0.45.

Ezion is not the only company that adjusted the conversion terms of its warrants after a rights issue. Viking did the same after its rights-cum-warrant issue in May this year. Innopac also issued free warrants (but did not adjust the exercise price) after its rights issue in Jun this year.

Perhaps the most generous adjustments are made by Olam, which adjusts the conversion terms of its warrants even for ordinary dividends. For example, in Aug this year, Olam declared an interim dividend of SGD0.035. The exercise price was adjusted from USD1.12 to USD1.09 and the no. of warrants was increased by 1.8%.

Thus, there is a small cushion that warrants provide in the event of a rights issue.

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