When is the right time to support a call for cash

I have a question recently on warrants. I believe it came out from an article I wrote 3 years ago, which is here.

The question from this person is as per below:

Hi there Felicity,

I read an old article on your blog regarding on how pure warrants exercise will only enrich the existing shareholders.

Isn't it warrants exercise is almost similar to a right issue? whereas they both:

1.) have the right to subscribe to certain amount of share at a pre-determined exercise price in certain period of time?

How is a pure warrant exercise worse off as compare to a right issue with free warrants as a sweetener?

I felt that it would be good to share my opinion on what's the difference between

1. free warrants ONLY, 
2. rights issue (together with warrants) and 
3. private placements.

The above are all equity fund raising. 

As you can see, all three above are exercise that calls for additional cash from shareholders. If the company is calling for more cash, one very important point to note (or question the company's management) is 

"DO THEY REALLY NEED THE FUND AND WHAT FOR?"

If the company needs the fund for expansion (or improve its debt / gearing level) and as shareholder, if we like the idea, it would be good to support if we have the extra cash. Do note that these are cash calls and the additional funds that the company is asking from its shareholders will go towards the management for them to manage and use.

One should read the prospectus to decide whether the call for cash is warranted for.

Now, let me go one by one as below.

Private placements

This usually goes to the third parties - meaning the call for cash can go through an investment bank and the company that is raising the funds will get help from the bank to help them to raise funds or the company can offer it to parties whom they probably know. Not my preferred method (for a minority shareholder) as this often can go to people they know and those people would get a preferential treatment over the existing shareholders. Why should that be as it is ALWAYS the shareholders that should get the preferential treatment - not another third party.

Only thing when this is good is when, the management or the Board felt a rights issuance will not be successful (as can be too difficult to justify whereas a small group may understand the company better) or the offering is small i.e. a 10% of the existing share base, then a private placement is made. However, private placements of this kind is not transparent enough and we also know that investment banks would be more than willing to help the companies rather than protect the minority shareholders.

Good thing about private placement though is the exercise is much faster than rights.

Rights issue (sometimes with warrants)

This happens when the management who is also the majority shareholders is asking everyone to chip in.

Shareholders have to weigh whether the strategy to raise cash is the right thing to do. I can give an example of WCE (Keuro), where it raised further cash for its equity injection portion for the building of the West Coast Expressway. That, I am definitely ok with it as it allows the shareholders to make decision and the project is a good project. The good thing about rights is that everyone (almost all the time) get the same treatment. A large shareholder will take the large portion, while small shareholders take smaller portion which is equitable.

Main thing to see here is whether the call for cash which will go into the hands of the management is the right thing to do as once a person parts with his money, he has no control except voting rights.

Why with warrant then? More than one reason actually. Sometimes, it allows the company to make the rights sweeter as it gives the party who come out with cash feel that they have more things than the newcomer shareholders. I agree that it is a debatable thing but for the person whom come out with new equity portion, it is still ok to be structured with warrants.

Moreover, the company may feel that they will not need all the cash at that particular moment, hence a warrant that in the event becomes in the money, it is possible for the company to raise more cash in the future rather than diluting the shareholders upfront. Note that warrants does not qualify for dividends while common shares do.

Free warrants (without anything that comes with it)

Worst of the lot. It is usually by companies with management who are speculating with their own stocks. They want to make the shares attractive - first for people to buy more of the parent shares (so that they can sell, usually) as the buyers will get so called free warrants. Speculators have to be warned that it is not a zero sum game for minority, it is a negative sum for minority as the controlling who decides what to do may sell to you above value. 

Second, for the majority shareholders to also sell the warrants as it is tradeable.

Third, if in the event the warrants become in the money, it will dilute the shareholders further and the cash (from exercising) goes to the management for use - in which case whether put to good use can be doubtful.

I strongly recommend good companies not to do free warrants ONLY as it just put the brand of the company into back-burner. Anyway, why would good companies do that as they have reputation to protect. Only companies who have no reputation to protect do weird stuffs.

In any case, whichever companies that are doing cash call, we as shareholders have to study the intention and objectives thoroughly.

Keuro-WE: Let it go!

Well, I have just let go 6000 units of Keuro-WE.

If you have read Chinese newspaper, Oriental Daily, basically the project has already commenced. Some part of it is expected to complete by 2018, while the entire project supposed to complete by 2019. So what is the expected risk in this project - you will have to hold for long term and will not know how good a prospect it will be. There is not going to be dividend for the next few years, at the very least. For now, I am hoping that the stock will go into consolidation phase if that is the case.

My portfolio looks like below.

Keuro's warrants: Why 2 years exercise period

I have posted several times about the different traits of a Warrant here. There are cases where warrants act as a sweetener for the shareholders to subscribe to the rights. Warrants can also be used as a tool for companies to raise more funds - not immediate but within the exercise-able period. This is especially true when the warrants is in the money. Usually the exercise period for warrants in Malaysia is either 5 years or 10 years, hence allowing the shareholders time to exercise it.

If it is for the management and controlling shareholders tool as a play, they may issue the warrants to be used as a unit just for sale. Why would one have more dilution to their stocks if they do not meant to exercise it? In this cases, one can see that the warrants have very little value but since it is tradeable and usually it is low in price. Recently, with the trading charges so low, at every 0.5sen, the traders are already profiting. That's precisely what I was pointing at in one of the articles. If the warrants in the eyes of the shareholders is not worth the money, and they do not want to cough up more to pick up more shares, they usually sell. Let the fools have it, why not!

In the case of Keuro's warrants, I believe it is used as a sweetener as well as a tool to raise additional funds - funds that Keuro does not need now but over the next 2 years it will need. As most know Keuro is raising funds for its WCE project which is costing RM5.9 billion now. Usually, these projects the cash needed are not immediate but will be needed on progress over the next 4 -5 years of the project duration. This is precisely why the exercise period is 2 years and not 5 years as if it is 5 years, it may be too late to raise the cash anyway. In 5 years time, Keuro does not need the cash. It needs it earlier. This is also probably why the exercise price is put at a lower price - RM1.18, closer to the parent price.

Whether the warrants will be exercised will depend on whether it is in the money. As it is the exercise price is RM1.18. Today, Keuro's price RM1.10 where it is pretty close to the exercise price.

Rights, warrants, buybacks, dividends 101

Seriously, what does one expect from stocks investments? Capital appreciation, dividends, excitement - win or lose, learning experience?

Investment is a serious game. Unless, you are into it as a replacement for your weekly casino frequency, one should study the behaviour of the management, owner, company besides their financials which is equally important.

In studying the company's management, one should look at the behavioral trend of the company with their financials, which is why how these companies do their capital repayment, dividends, rights, warrants are important.

Think of companies as like running a family's expenses - whenever you need money, you borrow or ask from other members of family maybe in the form of capital investment. If you have more than enough, you will give more to your siblings, parents. You do not take in more debt if you do not need them. You do not mislead your family members that you need more money when you do not need them in order for you to buy a bigger car or a bigger house.

Similarly, rights, warrants, dividends and even buybacks are the same conceptually.

Dividends - Dividends are important when the company feels that it has more than enough money to be used for a period say more than a year and it is willing to share with you, the shareholders the extras beyond its need for operations. If it does not have enough or feel that it needs to use the money for further expansion or in anticipation of future needs, it should not be ditching out more than it should. If you follow my blog, I am wary of companies that issues dividends and yet over the short term, requesting for more money through rights.

Of course dividend is important to most shareholders, as this is a gesture that the company is showing to its shareholders that it is willing to share its extra cashflows - which is why sometimes, dividend policy is useful.

Equally useful to the shareholders is share buybacks. The flipside of buybacks is only that when the management or controlling shareholder uses it for their advantage. It is when they uses the company's financial resources to buy the shares from the market but at the same time, selling their own shares. Buybacks are good when it is used as a tool to provide support for its share price especially during high volatility and even more so, when the prices of the shares are undervalued. One should not underestimate the confidence that the management can create towards its share price especially during high volatility by doing buybacks.

On the other side to sharing their additional funds through dividends or capital repayment, is rights issue. Rights issue is when the company is asking you for more money due to their needs. As a shareholder, we always entrust the controlling shareholders to manage the money carefully - which is why one would probably wonder why I am writing an article on a company which I do not intend to invest in anyway - on its rights issuance.

In my mind, that company does not need the fund - it uses it for its controlling shareholders benefits - which you, as shareholder or potential shareholder have to be careful of. You do not give money to one who will probably misuse your money. Worse still in that case, it is not beneficial to the shareholder to not pick up the rights and it is not beneficial either to pick up the rights as the money may not be used in the right manner. The shareholders of Bright are caught in between a rock and a hard place.

Almost all companies need to reinvest or do investment. Anyone who underinvest, may lose out in the future as competition will always take opportunity on any conservative companies that do not take the more aggressive or continuous investment approach. in this case, rights are not always wrong. On that note, quite a lot of companies - Gamuda, IJM, WCT etc.- that do rights in their early days would go on to be successful as they have acted upon the rights correctly and carefully and by sharing that piece of investment needs with their shareholders. We as shareholders, can only hope their decisions are the right one.

What about warrants? Warrant is an option to pick up more shares of the company in the future. As for the company, it is a way for the company to raise more funds in the future. Warrants should not be used as a tool for the controlling holders to cash out, as that action is almost like misleading the investors - many of whom may be ignorant. Worse still if one is to buy the warrants from the market, and they end up out of the money. The warrants are worthless.

And even if it is in the money, one should think twice of exercising the warrant as putting more money into the management that you do not trust, is something which you should not do.

Freight-WA may be interesting if its risk you are seeking

I have looked at Freight Management's results for the 1Q 2013. It seems that the company is on track despite the reducing gross profit margin. You can see that the company is still trying to grow with controlled investment into some of the areas. I have liked the company for its asset light business as compared to some of the other logistics companies.

However, another play which can be possible is the Freight-WA. Its exercise price is RM0.97 and expiry is sometime around 2017. Current parent price is around RM1.35. With the warrant around RM0.39, it is close to in the money with about 4 years of holding.

Warrant would be good if you have a good feel of the company moving forward. If the company trends the other way however, you can potentially lose all your money. Its higher risk, for those who like that.

SP Setia and its betrayal to its warrants

Warrants is a fantastic derivative which is often very useful to its master holders. Whenever there are rights issuance, the issuer will usually be provided with a so-called sweetener to sweeten the exercise. The calling of rights happens when companies are in need of funds injection and it is often the fear of the issuer that minorities may not take up the offer - hence a sweetener called warrants are usually provided for free. It is like free baby shares (if you are picking up the shares rights) which has some value when it is opened for trading.

As for investors who would like to buy or sell warrants, its volatility is much higher following its mother share especially those that are close to being in-the-money. It is often good for shares that have good potential, undervalued and the warrants are still having some time to expire. The same cannot be said for shares that have near termed expiring warrants though.

SP Setia is a wonderful share despite me not so interested in property stocks. It is probably the best developer in the country for now. The properties that it built probably has gained much premium to its original costs due to the brand and quality that are associated with the company - hence, it is one of those few developers that can actually be traded substantially above its NAV. Hence, with the brand over time, the share is good but in the short term, its shares can be traded at any price as there is less fundamental involved in short term trades.

The weird thing is that shareholders were offered at RM3.95 for each ordinary and warrants at RM0.96 by PNB and Tan Sri Liew together, (CEO of the company) sometime around February 2012. At that point of time, there was much brouhaha calling that the offer was way undervalued etc. etc. There were calls for much higher price. In fact, the independent advisor, call for shareholders not to take up the offer as the so-called RNAV (revised NAV) is actually RM5.00 - so why sell?

At the end, many sold anyway and PNB (the main offeror) and partners were holding more than 79% at that point of time. See below.

On the other hand, the independent advisor asked shareholders to sell the warrants as it was almost 10 months to its expiry. Hence, the offerors ended up holding up to 88% of the warrants which has an exercise price of RM2.99. From there we know that there are less than 25 million warrants shares in holdings of the minorities - important to know the number of shares left for trading (but of course PNB can still sell). I do not know where these group represents - probably they are the believer of SP Setia really worth much more than RM3.95.

Boy, could they be regretting? As SP Setia's shares did not perform to its expectations in terms of price. Financial results on the other hand, was actually good. And if you look at the price below, its share price had a surprising huge drop within say 15 days from around RM3.60 to RM3.00. Why a sudden lost of confidence in the stock? Why and who is behind the selling? It is not one of those who owns more than 5% as no major announcements were made. Tan Sri Liew leaving SP Setia - again the same old news regurgitated?

Trading of SP Setia - ordinary share

It is ok to hold on to a stock which is trading at RM3.10 now as there is no expiry for SP Setia. As long as its performance holds and the company sells more houses, it will be back to RM3.95 in no time, I believe. The one that is running out of time is the warrant which is due to expire in 21 January 2013 and left with few more days to be traded (3 Jan 2013). It suffered a similar huge drop (but much much higher percentage drop obviously) following the mother share. Time is running out, but the mother share is still trading at above the exercise price of RM2.99. Whatever it is, the holders still need to come out with cash and pick up.

Trading of SP Setia warrants

I know that the warrants have been largely traded and as at yesterday, it is still out of the money. In fact, the same warrant share was traded several times on the same day (look at the volume) during the last few weeks as traders like shares that are trading at low price. One thing I know, PNB has exercised some 79 million warrants shares (or even more). There is also a need to increase the public shareholdings to 25%. But you will never know, the share price could be left (if it drops to RM3.00) with the warrant shareholders holding a worthless paper at the end of the day.

Remember, at the same time with the drop in price, SP Setia is proposing for several things - private placements of up to 15%, ESOS of up to 15%. All these are based on last 5 days traded price prior to the exercise and with discounts. If I am an employee or someone who is taking up the private placements, obviously the lower the share price the better. Or could it be someone is buying the warrants...