Convertible Stock Warrant for Promoters – Share Warrant Read between the lines – Part 2

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In our preceding blog we had discussed equity warrants and how promoters are benefitted through the same. In this part of the blog we are providing a few Examples how the promoters get warrants at lower price as compared to current market price and then book profit. Further we are providing an Example when the promoters make losses on the warrants. The best part is, even after making losses there are a few that make further larger warrants issuance to Make up for the losses in the previous attempt. Further such examples also indicate that the warrants issues are mostly beneficial to promoters and not the company minority shareholders.

Share Warrant – Issuing shares at lower prices and selling at profit

While we spoke about a textile company in our part 1 of the blog (Convertible Warrants for Promoters – Read between the lines – Part 1), here is an example of a company from the textile industry. This particular company had exposure to textile, paper, Real estate and Cement as well. The company eventually sold its cement division. This company had issued 1.865 crore preferential warrants to the promoters group at a price of Rs 354.90 per warrant.  The warrants were allotted on June 4, 2014.  And on March 30th, 2015 the promoters converted 84,70,000 warrants and then the rest of the warrants 1,01,80,000 in the month of December 2015.

Share Warrant Meaning – Understanding Process

In the Above case if we calculate the amount paid by promoters for the above warrants would be as follows.

= [(1.865 crore warrants * (Rs 354.90))* 25 Percent]

= Rs 165.47 Crore

As stated earlier the promoters converted the 0.847 crore shares on March 30th, 2015 and remaining 1.018 crore shares in December 2015. They had to pay the rest of the amount – i.e. 75 percent of the pre-decided price. So they paid Rs 496.41 crore to make full payment.

Now the basic calculation shows that on March 30th, 2015 the scrip was trading at Rs 638.90. Hence the promoters were already sitting on the gains to the Tune of Rs 240.55 crore.

= (Rs 638.90 – Rs 354.90) * 0.847 Crore shares

Similarly the promoters further converted 1.018 crore shares in December 2015. The calculations show promoters were making a profit of Rs 221.72 crore on this conversion.

Even if the promoters had sold all shares at this price, they would make a profit of Rs 406.2 core on complete transaction. In just 18 months Rs 165.47 crore would provide them a profit of Rs 406.2 crore. Look at the kind of leverage and returns promoters are generating. In a normal scenario a retail investor won’t get such leverage.

Eventually in March 2016 the promoters sold 27.46 lakh shares at Rs 524.15. So if we consider the issue price of Rs 354.90 and selling price of Rs 524.15, the promoters are making a profit of Rs 46.48 crore on this transaction.

So the above case clearly shows that with exercising the warrants the promoters’ stake in the company increased to 50.21 percent in December 2015 as against 40.23 percent in December 2014. And the promoters acquisition cost for the same was Capped at Rs 354.90 per share. As the economy shows recovery and when promoters are seen buying the stock – the stock price is expected to witness an up-move. In such a scenario the promoters would have to pay a higher price to get the 10 percent rise in stake. However the warrant issuance helped them increase stake at a fixed price.

An investor would appreciate that even though the regulatory guidelines state that promoters cannot sell shares received via warrant allocation for a period of 3 years. However, when the promoters already have many existing shares of the company with them, then they can safely sell the existing shares and in turn, get a profit from the warrant allotments.

The above example shows that the promoters are benefitted more through the warrants issue. Rather we would say, it is 75 percent beneficial to the promoters and 25 percent beneficial to the company.

Mostly beneficial to promoters – Not always to the company

As we understand the basic share warrant meaning, now if we take it in simple terms – promoters need to make an upfront payment of25 percent at the particular fixed price. Then at the time of conversion 75 percent is paid for. So imagine a scenario if at the time of conversion the share price is trading below the allotment price. No wonder the promoters won’t convert the shares at losses. Hence they would forfeit the 25 percent of the amount paid as premium. So in this case the company won’t get additional funds.  Company gets the 25 percent of funds without further dilution. However the possibility of such an instance is lower. Hence we opine the warrants issue to the promoters is beneficial 75 percent to promoters and 25 percent to the company. Before 2009, the promoters were required to pay only 10 percent of the money at the allotment and balance 90 percent at the time of conversion. However, from February 2009, SEBI changed the guidelines and increased the upfront payment to 25 percent.

When shares trade below allotment price

While we discussed the scenario when the share price trading is above the allotment price, in certain cases the market Crash results in stock price trading below the allotment price. Let’s take an example of one company where promoters suffered losses to the tune of Rs 1 crore.

The Company had allotted 15,00,000 Convertible Warrants of Rs. 70 each (Rs. 7.00 per warrant paid on allotment) on preferential basis to Promoters and Directors, their friends and relatives on 24th December 2007 (Earlier only 10 percent amount was to be paid). With the share price trading below the allotment price, none of the subscribers of the warrants had exercised their option and the same expired in June 2009. As a result Rs. 1,05,00,000 received on allotment of warrants was credited to the Capital Reserve Account. No wonder the promoters and director made losses.

But then the promoters came out with further larger warrants issued after that. Here in this warrants issue, the Company had allotted 23,26,110 Convertible warrants of Rs. 32 each (Rs. 8.00 per warrant paid on allotment as SEBI changed increased the upfront payment to 25 percent ) on preferential basis to promoters and directors in July 2009. Of the above, 8,20,222 warrants were converted in September 2009 and balance warrants 15,05,888 were converted in October 2009. The balance amount of Rs. 24 per warrant was duly received before exercise of warrants. Just to put in perspective, the scrip in October 2009 was trading at Rs 76-77 per share.

In this case the total profit made was as follows

Rs 32 * 23.26 lakh shares = Rs 7.45 crore were invested.

After conversion the shares were trading at Rs 75 per share. The total value of the same will be as follows

Rs 75 * 23.26 lakh shares = Rs 17.45 crore

Hence the profit Made is to the Tune of Rs 10 crore. As against the loss of Rs 1.05 crore made earlier.

All in all the warrants issue is mostly beneficial to the promoters and less beneficial to the company. If any major positive announcement comes after the conversion of shares or Warrant allotment, it should be considered as insiders trading timed to perfection. Again not all such warrant issues should be seen with negative aspects. However if only promoters are getting benefitted, it speaks a lot about the promoters quality. Now as we understand the share warrant meaning in real sense, from now onwards it is duty of retail investors to scrutinize the stock warrant issues to promoters in detail.