Wednesday, December 14, 2016

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 


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.


Multi said...

Great write up Felicity.

Pure free warrant has been used by controlling shareholders to salvage whatever they can before the ship is sunken. Not only on Bursa but also on other exchanges. In Malaysia, red chips companies specialize in this kind of exercise and many still got attracted by this sweet.

Eventually earn a sweet and lost a factory.

Tabula Rasa said...

Excellent post, Felicity.

Another point to note is that warrants, whilst relatively common in Malaysia, is little seen elsewhere.