Should warrants be listed?

CALL warrants or just warrants are derivative instruments issued by a company to raise capital at a future date based on an assumption that these instruments will be exercised during the warrants’ lifespan.

These warrants are issued by a listed company and are typically issued as a sweetener to a corporate exercise, especially in a rescue scheme or a rights issue. There are also instances where companies undertake a bonus issue of warrants as a “reward” to shareholders. This was the case in the recent Top Glove Corp Bhd bonus issue of warrants on the basis of one warrant for every 20 shares held.

In most instances, the warrant exercise price is fixed at a certain price range, which is usually at a premium to the volume-weighted average price (VWAP). In the case of Top Glove, the warrants exercise price was fixed at RM1.27 per share, which was a 9.6% premium to the five-day VWAP market price.

In another case involving Notion VTEC Bhd (NVB) last year, shareholders were entitled to receive one free warrant for every 10 NVB shares held. The exercise price of the new warrants was fixed at 44.5 sen, which was at a 10.01% discount to the five-day VWAP.

The two examples above show that the warrant exercise price can be fixed either at a premium or a discount to the five-day VWAP.

Both cases also show that the warrants were listed and traded, exercisable at any time based on one new share for every one warrant exercised, during the five-year tenure of the warrants. As of Thursday’s closing market price, Top Glove’s new warrant was trading at a 62% premium, and NVB’s at almost 20% premium.

Unlisted warrant

About a month ago, both YTL Corp Bhd (YTL) and YTL Power International Bhd (YTLP) announced concurrently a similar proposal entailing a proposed bonus issue of new warrants on the basis of one warrant for every five shares held.

The tenure was set for just three years from the date of issuance and at the same time, both companies announced that the warrants would not be listed.

In the case of YTL, between 2.21 billion and 2.27 billion warrants will be issued, based on the minimum and maximum scenario, and these ill have an exercise price of RM1.50 per share – a 44% discount to the five-day VWAP of RM2.661 per share.

In the case of YTLP, between 1.64 billion and 1.67 billion warrants will be issued based on the minimum and maximum scenario with an exercise price of RM2.45 per share, which is a 44% discount to the five-day VWAP of RM4.3721 per share.

According to both YTL and YTLP, the proposed warrants issue is to reward shareholders as well as to meet the future funding needs of the two companies. The companies also opined that the warrants issue will provide an opportunity to increase their equity participation.

Upon full exercise of these warrants, YTL and YTLP are poised to raise between RM7.3bil and RM7.5bil, depending on the minimum and maximum scenario.

Market’s response

In general, most investors are receptive to the idea of a bonus issue with warrants as these are traded in the market, allowing investors to offload them if they do not intend to exercise the warrants.

As warrants are options, the value of the instrument itself is dependent on the time to expiry, the volatility of the underlying shares as well as the exercise price, and whether the warrants are in-the-money or out-of-the-money.

Warrants are worthless if they are out-of-the-money and due to the limited lifespan, they too do not carry any value post-maturity.

However, during the tenure of the warrants, they do have a value based on the above factors, and in most cases, warrants trade at a premium to the underlying shares as seen in the Top Glove and NVB examples.

The premium is the percentage difference between the market price of the warrants and the theoretical value of the warrants, which is the market price of the underlying shares plus the exercise price of the warrants.

There are two market responses when warrants are issued, either as a sweetener in a rights issue exercise or even as a plain issuance under a bonus issue exercise.

First, is at the ex-date of the proposed issuance itself. While a bonus issue of warrants does not result in an adjustment in the ex-price, the market will typically adjust for the issuance due to the perceived value that investors are getting.

Second, upon listing, the warrants are given a theoretical value by Bursa Malaysia, which is typically the difference between the last traded price of the underlying shares and the exercise price of the new warrants.

If the difference is negative, the reference price on the first trading day of the newly listed warrants will be at the minimum price of RM0.005. The value of these warrants, even if they are out-of-the-money, allows investors to profit from the corporate proposal by selling them at a premium and without having to fork out any money.

Deep discount

It is rare for a Malaysian-listed company to announce a corporate proposal that entails the issuance of new warrants that are not listed. These warrants can easily be converted into ordinary shares once issued, but as they are issued at a deep discount, there is some form of market adjustment to the underlying shares on ex-date, akin to a rights issue.

Hence, it was not a surprise to see YTL and YTLP’s share prices fall by 26 sen and 44 sen respectively or 10.9% each as investors saw the proposal as a cash-call rather than a bonus issue of warrants. The market capitalisation of both companies too was depleted by RM6.5bil.

Perhaps the regulators ought to look at our listing requirements and ensure that investors are given a fair deal when it comes to fund-raising exercises. Having a deferred rights issue exercise and calling it a bonus issue of warrants is certainly not in the right spirit of what is regarded as a reward to shareholders.

Even if YTL and YTLP opined that the best option was this bonus issue exercise, the least they could have done was to ensure that the warrants were listed.