Tuesday, September 21, 2010

Warrants 'Renewal' Should Be Abolished

hng has left a new comment on your post "Islamic Finance, Malaysia's Bright Light":

Hi Dali

Can you advice on PJD and PJD-WB? i’ve bought many PJD on hope on its warrant on basis 3 for 8 as well as its upcoming dividend of 5sen (6.6% yield). PJD have slowly show some movement from 71sen to 76sen now, but its PJD-wb move much more from 4.5sen to current 7sen, a gain of >50%!?

As these PJD-wb also entitle 3 for 8 warrant, its implies market price upcoming warrant at least 20sen (7sen x 8 unit) + (2sen x 3 unit) divided by 3 unit.

What is your opinion on both PJD and PJD-WB, should i exchange in order to gain more exposure?



Hng,

You are right and the market is pricing the old warrant correctly, and yes, the new warrant should trade between 20 sen-25 sen. Yes you should exchange and get more exposure. I do not follow PJD but on surface, the company is OK. Recently announced full year's net profit rose 133% to RM52.76m, and has a cash balance of RM104m.



Now lets get to the principles of warrants and why these "clauses" to allow for warrants to be renewed, or renewed via a rights issue should be abolished. Warrants are usually issued together with a bond, which means the warrant is detached (i.e. from a convertible bond). The number of warrants multiplied by the conversion price should equal to the bond amount. Hence the basis for a normal warrant is to get it to be converted so that the premiums paid by those warrant holders who convert into new shares will be collected to pay off the bond eventually.

This works if the company performs well, or rather the share price performs and trades much higher than the exercise price. As the time value dwindles or the gearing dwindles towards 1.0x, the warrant will start moving to the no premium or even discount range. This will bring about investors buying the warrant to convert into shares.

If your exercise price was higher than your mother share price towards the end of the warrant period, nobody will convert and your warrant will find its way towards 1 sen level. If a company's warrants do not get converted, it basically means the company will have to fork out funds to pay off the bond at the end of the loan period, or renew the loan on new terms.

http://i1011.photobucket.com/albums/af236/sgdaily12/yajimamaimi18.jpg

The important reasons why this "renewal" thing should be abolished:
- its not a "structured" or transparent decision, the decision lies with the management and/or board of directors
- some out of money warrants do not get extended, some do, its highly discretionary
- the basic rights of people who buy warrants should be protected here, by allowing "renewal" you make it impossible for warrant holders to sell or buy on full logical calculation
- it gives rise to insider trading of a massive scale if insiders were to collect at 1 sen or 2 sen for the longest time and then announce the warrants being given a new lease of life

Time value and gearing are the cornerstones of valuing a warrant, to suddenly give an out of money warrant an additional 5 or 10 years is a huge gift.

If I bought a warrant at 20 sen with 12 months to expiry and the mother share is 1.00 but the conversion price is 1.30, thats a clear investment as the gearing is stupendous at 5x even though the premium is 50% (20 sen + 1.30 / 1.00). After 6 months, the share price stays the same and the warrant moves to 10 sen. Gearing is 10x now while premium is at 40%, which is very high with just 6 months left.

Say with just 60 days to expiry, and the mother share stays at 1.00, the warrant would have dwindled down to 3 sen or 4 sen as it looks near impossible for the mother share to move more than 30% forward in 60 days. Herein lies the dilemma, when do an astute warrant holder sell??? Should he/she factor in a "maybe" the warrants will be renewed??? That is pure b.s. especially when its so "whimsical and totally at someone's discretion" which you have no privy to!!!

In PJD's case, investors might say its a good thing, especially for those who held onto the warrants. What about the really smart investors who sold at 15 sen, 14 sen, 13, sen, 12 sen, 10 sen, 9 sen, 8 sen, 7 sen, 6 sen, 5 sen, 4 sen, 3 sen, 2 sen and ta-dah 1 sen???? What about their "loss"? Were they stupid, noooo, contrary to that, they were smart and knew how to value and trade a warrant properly. Who gained? The stupid investors who bought all the way down below 5 sen (unless they knew something beforehand).

http://i1011.photobucket.com/albums/af236/sgdaily12/yajimamaimi60.jpg

This is blatantly wrong if you weigh this in terms of basic tenets of investing. There should be no guessing and all must be transparent. I would like to haul up all buyers of PJD warrants below 3 sen, and get to the end owners of those trades, don't you?

I am not implying that there was something sinister about the renewal of PJD warrants but we should safeguard a fair level playing field for investors. Why are there guesswork and doubts about this, they should be removed in order to provide a more transparent investing environment.

To rectify that, the rules should be clear from day one of warrants issuance, that the company WILL renew the warrants if it stays out of money on expiry for another 5 years OR that they WON'T. Isn't that fairer?

c.c. SC and Bursa

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Thanks to a swift comment, I will provide a swift reply in brackets.
kl said...

Dali,

Some elaboration to your comments are in order;

PJD-Wb were issued together with a rights issue of shares in 2000, not a bond issue

(Doesn't matter, the principles are the same, whether they were a rights issue attached or even totally free warrants in the first place).

PJD-Wb are not being renewed, will expire in Oct '10 after its 10 year life and out of the money.

(I use the word renewed in brackets. We all know what I am trying to get at. PJB does not get out of jail card because of some twists here and there. Same principles of transparency are lacking).

The new PJD-Wc is a new issue on a basis of 3:8 to both PJD and PJD-Wb holders for another 10 years at 2 sen, the proposals being interdependent.

(Again, does not matter whether it is a 1:1 or 3:8 or even 1:50, the principles have been violated).

PJD does not need the few million Ringgit raised from a cheap new warrants issue. The exercise seems to be an attempt to rescue some value for Wb holders more than anything else. No prizes for deducing who the major holders of Wb are. They are also the major shareholders. (I am not implying PJB needed the money. I wasn't even targeting PJB. I even mentioned how well PJB did in their recent results. It is exactly the creation of value" for major shareholders of the warrant that I am disputing ~ unfair, totally unfair to those who have sold the warrants for the past few weeks or even months).







5 comments:

kl said...

Dali,

Some elaboration to your comments are in order;

PJD-Wb were issued together with a rights issue of shares in 2000, not a bond issue

PJD-Wb are not being renewed, will expire in Oct '10 after its 10 year life and out of the money.

The new PJD-Wc is a new issue on a basis of 3:8 to both PJD and PJD-Wb holders for another 10 years at 2 sen, the proposals being interdependent.

PJD does not need the few million Ringgit raised from a cheap new warrants issue. The exercise seems to be an attempt to rescue some value for Wb holders more than anything else. No prizes for deducing who the major holders of Wb are. They are also the major shareholders.

hng said...

Dear Dali

Thanks for your comment on PJD. I do agree with you about renewal exiting warrant solely for the reason that the warrant is out of money is unfair.

However, at least PJD propose come 2 month before the actual expire date of its warrant. This is far better than MALAYSIAN AE MODELS HOLDINGS BERHAD (MAEMODE) which only propose renewal its warrant AFTER expire date on the basis 1 new warrant for every UNEXERCISED warrant (out of money) !!

(i) a renounceable rights issue of up to 45,913,667 new warrants in MAE (“New Warrant(s)”) to all the shareholders of MAE, on the basis of one (1) New Warrant for every three (3) existing ordinary shares of RM1.00 each held in MAE held on an entitlement date to be determined later (“Entitlement Date”); and

(ii) a restricted issue of up to 10,244,711 New Warrants to the holders of unexercised 2005/2010 warrants on 17 September 2010, on the basis of one (1) New Warrant for every three (3) unexercised 2005/2010 warrants held on the Expiry Date.

kl said...

If you go back to 1997/8 during the Asian financial crisis when KLSE stocks were absolutely thrashed, you will find the original reasons for SC's nod for warrants extension or renewal. This was to help desperate warrant holders and mind you, all warrants then were out of the money. Was this unfair? Few interested parties objected to this, during or just after, a period of crisis when the world seemed to be crashing down. Shareholders and warrant holders at company EGMs invariably approved warrant extensions.

Should SC have relaxed the rules on warrants even then? Once you let the genie out, you have a problem putting it back in the bottle. Even when circumstances have changed.

Salvatore_Dali said...

kl,

u r right, they SHOULD NOT have done so following the crisis ... it smacks at the investing principle of fairness ... even in calamity of the 97 crisis ... what about those warrant holders WHO READ THE CORRECTLY and was anticipating a major correction, and sold before prices plunged ... what about them ... the thing is this renewal or extension IS NEVER ONE SIDED , whoever gained, somebody have lost just as much. And nobody seemed to care about the smarter ones who lost money.

brotherlone said...

dali,

warrants renewal will never be abolished,

the issuers themselves, have their prop desks taking up huge positions in structured warrants.

how can a same bank, being the same advisor for some corporate exercise issue structured warrants like a month or two before announcement?

and if nothing happens... renew lar, if not it will zeroised... but then again.. costs of subscription is minimal

lots of gorden geeckos around