April 1, 2017

Preferential Allotment of Warrants to Promoters (Q&A)

www.drvijaymalik.com has a section dedicated to answering queries of readers: “Ask Your Queries”. Over time, many readers have asked their queries related to many aspects of stock analysis and sought clarifications about investing. I have responded to these queries as replies to their comments.

“Q&A” series is an attempt to share the queries & their responses, which have featured on “Ask Your Queries” section, with all the readers. The primary aim of this new feature is to share the knowledge with other readers of the website, who might have similar queries.

The current article in this series provides responses related to:
  • Preferential allotment of warrants to promoters


Answers to readers' queries related to preferential allotment of warrants to promoters, exercise price


Query



In one of your recent articles on analysis of Granules India Limited, you have mentioned that allotting warrants to promoters is negative.

I just wanted to ask if allotting warrants is negative even if they are allotted at a price higher than the current price of the stock. E.g. if a company's stock is trading at Rs 100 and it allots warrant at 120, would that still be negative.

One example is of Goodluck India. They have issued warrants at an exercise price of Rs. 125 when the market price was below Rs 90 (Dec 2016).

Thanks

Author’s Response

Hi,

Thanks for writing to us and bringing the case of Goodluck in our notice.

This is the first case that we have seen that the warrants have been allotted at a price higher than the prevailing price. In all other cases, the allotment price was below the prevailing share price.

In the case of Goodluck, it remains to be seen whether the promoters exercise their right to buy shares at Rs. 125/- despite the share price staying below the allotment price (₹125). An investor should note that warrants involve the promoters paying 25% of the money at allotment i.e. 125*25% = 31.25 per share at the time of allotment and would pay balance 75% i.e. 93.75 per share at the time of exercise of warrants and their conversion into equity shares within next 18 months. The price that the promoters would effectively pay total ₹125/- per share for getting shares irrespective of the market price of shares on the day of the exercise of warrants.

Common logic says that anyone holding warrants would not exercise them to get shares at a price, which is higher than the price at which he/she can get shares from the market.

More so, if the intention of the promoters is to infuse money into the company, which in the case of Goodluck is ₹125 * 1000000 warrants = ₹12.5 cr., then they should simply get all the shares at the current market price and give ₹12.5 cr. to the company so that the company may use it for the purpose for which it needs money.

The entire gimmick of paying 25% now at the time of allotment of warrants and then keeping the option to pay 75% at the time of exercise, which the promoters would decide based on whether at the date of exercise, the promoters are making money or not, seems like a facade to us.

If the promoters pay 25% now and let the warrants expire due to the market price being consistently lower than the exercise price in future, then it effectively means that the promoters did not have the true intention of infusing 100% of the money. Or that the company did not need 100% of the money. It might be that the company needed only 25% of the money, which promoters put in by way of warrants allotment and the right to get shares in future at a discount is the payoff that promoters would enjoy as a consideration for giving 25% to the company. The company might not need the balance 75% at all.

Nevertheless, we believe that if the promoters wish to infuse funds into the company, then the company should straight away issue additional shares to them at prevailing market price and get 100% of the funds upfront rather than letting the promoters speculate at the company's share price by holding back 75% of the funds as happens in case of warrants.


Hope it answers your concerns.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Follow up Query

Thanks for the detailed response.

Just to check if I understand correctly, so this (issue of warrants by Goodluck India) according to you is not an obvious red flag, but they could have injected money into the company more efficiently and in a less pretentious manner.

Is that right?

Author’s Response

Hi,

We believe that if a promoter wants to infuse money into the company, then he/she should go ahead and straight away infuse the money by subscribing to additional shares at the prevailing price on the day. We do not appreciate the structured arrangements like warrants for the reasons elaborated in our response earlier.


Hope it answers your concerns.

All the best for your investing journey!

Regards

Dr. Vijay Malik

Query


Hello Sir,

What to do in case of warrants given to the promoters at a price above the market price? Is it a positive sign? For example, I was going through the annual report of a company, I found it had issued warrants for a price which was higher than the market price at that time and did not increase beyond it in next 18 months. Correct me, Sir, if I am wrong? 

Why did company issues warrant at higher rate??

Author’s Response

Hi,

Any such instrument of part upfront payment and balance payment later with freezing of acquisition price should be seen with caution. Warrants issued at a premium are still better than those issued at discount to current market price, as at least in the case of issuance at a premium, the interest of the promoters and minority shareholder are somewhat aligned. However, the concept of freezing of cost of conversion irrespective of future market price still benefits the promoters at the cost of minority shareholders.

Warrants might have been issued at a premium in the mentioned case as a result of the formula to determine the conversion price, which would have been applicable at that point of time.

Hope it clarifies your queries!

All the best for your investing journey!

Regards

Dr. Vijay Malik

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DISCLAIMER


Registration Status with SEBI:


I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:


Currently, I do not own stocks of any of the companies discussed above