Over the last few weeks I have increasingly been observing the phenomenon of lot of companies which had issued warrants to their promoters during the hey days of the late 2007 coming out with statements that the promoters have decided not to exercise the warrants. This in my view is a very serious issue which also needs some oversight. These warrants were issued by taking in just 10% of the total value of the shares to be issued when the warrants are exercised. To explain it in simple language, promoters could take the option of increasing stake in companies at a fixed price by paying just 10% of the total amount due on full conversion.
Among the companies that come to mind at this point of time, that have issued these statements include well known companies like…… ok i won’t name companies just to avoid controversy. There are more than 50 companies that have done this thing. The reason for the non exercise of warrants is normally that the market price of the stock (obviously) is much higher than the exercise price of the warrants and as such most of these companies are going in for issuing fresh warrants to promoters which is generally below the current market price as it involves some averaging of past price data and the way the markets have moved up the current market price is normally at a premium to the new issue price. The same thing was prevalent at the time when the warrants were initially issued as that was also the time of a strong bull run. In some cases the warrants were issued at the time when a number of companies were raising money through various instruments from investors. My main issues with this phenomenon is as follows
– Normally when a promoter group takes a warrant at a current price investors perceive it to be a vote of confidence of the promoters towards the operations of the company and in the mind of investors this tends to become a floor price (as the promoters themselves are willing to buy at that price ). As such by paying just 10% promoters could actually buy a long dated option which would give them an advantage over all other investors who have to pay the full price while buying the stock of their company. As such if the price falls by 50% subsequently there is no impact on the promoters as they just get away with forfeiting the initial amount and the investors are left with real losses of 50%.
– Lot of companies tend to issue these warrants at the time when they are making some sort of placement to investors and this creates an artificial price point which becomes a pricing benchmark.

– This is specially true in case of retail investors who feel that if a promoter is willing to buy at a particular price then that price should be a good price to buy the stock.

The recent move of SEBI where they have increased the initial amount to be paid at the time of issue of warrants to 25% is a good move as this increases the seriousness of the entire process. However this still leaves investors of companies whose prices have fallen 70-80% at a disadvantage as if the stock has fallen 80% and its original prices was Rs 100 then the current price is Rs 20. Now 25% of Rs 20 is Rs 5 which is lower than 10% of the original price of Rs 100. In the future also promoters will see the market price and then take a call on whether they want to convert or simply buy the shares from the market through the creeping acquisition route.
As an institutional investor who holds a large part of equity of a company that has fallen by 80% and one is still holding the stock there is no way that the Board of Directors of the company can be made to issue warrants to the investor. For example if an institutional investor was holding nearly 10% of the equity of the company (which is the maximum limit allowed) and was left holding the shares when the prices crashed they cannot participate in the process of averaging by subscribing to warrants.
Since promoters are as it is allowed to do creeping acquisition I believe that issuing warrants to promoters should not be allowed and it should only be allowed for non promoter investors. To give more flexibility in this regard the creeping acquisition limit can be increased to 10% per year.
Secondly if warrants are allowed to be issued and when warrants are issued to promoters other shareholders should also be given the option to participate in the warrant issue in proportion of their shareholding i.e. the warrant issuance should only be allowed like a rights issue. This will be fair to all shareholders.
Thirdly if the current practice is allowed to continue and if warrants are issued to promoters then the conversion should be made compulsory.

Some of these proposals if accepted can prevent false price signals and if the rights issue option becomes compulsory it will give all investors an opportunity to take a long term call on the company in the form of a call option.

This is an issue to be seriously debated in the interest of investors.

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