Convertible Warrants for Promoters – Read Between the Lines – Part 1

6 mins read
by Angel One

When it comes to investing we always say, more than the quantitative parameters it is the qualitative parameters are important. It is the quality of promoters that decides the future growth of the company. And while analysing the promoter quality a particular factor to analyze is – issue of share warrant to the promoters. The issue of share warrants may seem to be a very simple process. However there is a lot to read between the lines. In usual cases the issue of share warrants is considered as promoters increasing stake (again a positive factor). In many cases it is considered that – promoters are providing funds in difficult times (usually when stock prices are not doing well, such actions are followed). Let’s try to understand in detail the warrants issued to promoters with some examples. Let’s first understand meaning of Share warrant or what convertible share warrants are? Along with share warrant meaning lets understand the process of share warrant issuance.

Understanding Share Warrant Meaning

To put in simple words – share warrant meaning is – it is an instrument that gives a right to buy a particular Stock at a predetermined price within a stipulated time frame. It is exactly like the call options in the derivatives segment where the buyer of a call option has a right to buy.  Exactly the way in options one needs to pay a premium, even the buyer of warrants has to pay a premium. To be specific the buyer of the warrant pays 25 percent upfront of the total amount at the time of allotment of warrants. If 100000 warrants are to be at the conversion price of Rs 200, the total investment would be Rs 2,00,00,000 or Rs 2 crore. The simple calculation is Rs 200 * 100000 Warrants. And the buyers (or promoters) at this time have to Rs 50 lakh (Rs 2 crore * 25 percent). In simple words the payment of Rs 50 per Share is to be paid. After share warrants are allotted to the promoters, then they may approach the company any time within next 18 months and get shares from the company at the predetermined price irrespective of the current market price of the shares of the company.  Like in the above case, at the time of conversion even if the share price is trading at Rs 300, the buyer of the warrant can convert it at Rs 200 (being a pre-decided price at the time of allotment).  Stock warrants are usually convertible within 18 months from the allotment.

Share Warrant meaning explained

Again one would think on what basis the price of issue or allotment of shares is decided.  There is a set standard formulae by SEB for the warrants issuance price. The exercise price in the warrant allotment is based on a formula, which takes into account the average share price of shares in the previous six months. Therefore, at times, an investor may come across situations where the warrants are allotted to the promoters at a price, which is higher than the market price of the shares of the company on the date of warrant’s allotment. However again there is a lot to read between the lines when such allotments are made.

If we scrutinize the issuance/ allotment of warrants following are few of the factors that emerge.

  1. While most of the Retail investors consider share warrant as a positive act as promoters are investing funds, in a real sense we would say it is just a simple act of insider trading timed accordingly.
  2. Promoters get a chuck of shares at a cheaper price (compared to market price) and in a few years the promoters book hefty profits.
  3. In a preferential issue of warrants – We opine it is mostly favourable to promoters and less beneficial to retail or minority shareholders.

To understand the same in detail, let’s take an example of one Company from the textile sector. This textile company is into the exports of Textiles in different segments. In the year 2013 this company approved the allotment of 28,98,300 stock warrants to promoters in the meeting on September 11, 2013, at a price of Rs 17.25 per share. This was the pre split price and the post-split equivalent price would be Rs 3.45 (as the post split would be 1/5 of the current price). As a result the number of shares issued to promoters post-split would be 5x or 1,44,91,500). Again there was a clause of lock for a period of three years.

Post Split the trading price in September 2013 was Rs 5.45 per share. So a simple mathematical calculation suggests that on the day of Allotment only the promoters were making profits to the tune of Rs 2.9 crore.

(CMP Rs 5.45 – Issue price of Rs 3.45)* 1.44 crore shares = ~ Rs 2.90 crore

Here the promoters had made a payment of Rs 1.25 crore only. (Rs 3.45 *1.45 crore shares)* 25 percent premium paid. So just with Rs 1.25 crore investments the promoters were already making double of what they had actually invested. Now any price above the allotment or issuance price of Rs 3.45 would mean the promoters are making huge profits. Just to mention about the price movement, the price of the same scrip on December 2014 was Rs 60. Now just try to calculate the profit made by promoters. And the kind of leverage they got.

Profit is as follows

Rs 60 – Rs 3.45 = Rs 56.55.

Rs 56.55 * 1.44 crore warrants issued. It is more than Rs 81 crore. So by just investing Rs 1.25 crore the promoters made more than Rs 81 crore. So the kind of leverage promoters got is huge. Moreover the Company increased the stake in the Company by 3.20 percent.

To understand share warrant meaning – Read Between the Lines

Everyone would say, the management provided the funds to the company when the company badly needed that. They took all the risk and provided funds and hence they are handsomely rewarded. But as we say, read between the lines and here the other financials are to be analysed.

When (in FY14) the warrants were allotted the company had a sales of Rs 1468 crore and a PAT of Rs 110 crore. The debt amount stood at Rs 434 crore and interest outgo was Rs 50 crore. As against that the promoters just infused Rs 1.25 crore. Do you really feel it is a much larger amount provided during crucial times?

Just forget about the other financials as on March 31, 2014 the trade receivables stood at Rs 167 crore. A prudent collection policy or recovery policy would have helped them garner more than 20x of what promoters paid as premium.

The Game Changer– CDR Announced Later

While we are focusing on how the promoters made a killing by issuing warrants and retail participants though the promoters are doing a favour to the company. The real surprise announcement came later with the company announcing a process of Exit from Corporate Debt Restructuring (CDR). After the issue of warrants the company slowly started improving on the financial front and eventually after the three months of conversion of all warrants by promoters, the company came out of CDR.

No wonder, the promoters converted their stock warrants in December 2014, as they know the best out of all the people, about the financial position of the company at any point of time and that the company would be exiting the CDR very soon. As is normally expected with a company showing improving business performance, after the exit from CDR, the share price raced ahead and touched the lifetime high of Rs 249 in February, 2016, valuing the 1.44 crore shares converted by promoters from warrants at Rs 360 crore. A simple study shows how the promoters, by investing Rs 1.25 crore initially and then paying Rs Rs 3.75 crore as full and final payment, turned into Rs 360 crore in just 3 years. It is true the overall Market cap also improved. However promoters made a killing by taking leverage. This is not the case with retail and minority shareholders.  So the above example makes it clear that some warrants allotments are just insider trading with a perfect timing.

While we have discussed the first part of the observations, in our next part of the blog we would provide other examples of warrants issues.