Teller: What denomination do you prefer for your RM5000 cash withdrawal?

Uncle: I want more money, give me 50,000 number of ten sen coins please!

Dayang proposed a Rights Issue of 1 share for 10 shares held by the existing shareholder at a discount of 92 sen per right issue, ex-dated soon on 21^st November 2019. It was described as a “joke” by an individual shareholder for the company to go ahead with this type of exercise. Instead, he suggested that the company should give free warrants. He said by giving free warrants is akin to giving out cash Ang Pow because the warrants can be sold readily for cash. As a result, Dayang’s share price will go up immediately after the announcement and all the shareholders will gain. The company will also gain huge amount of money when the warrants are converted, and it will also gain when it can sell the placement shares at a much higher price.    

What a wonderful world!

So, who should be the decision maker for this corporate exercise, the individual shareholder, or the management who has been running the company, his consultant or investment banker?

Let us discuss in more details about some common corporate exercises.

What are some of the common corporate exercises?

Bonus issued shares are fully paid-up new ordinary shares issued free to existing shareholders in proportion to their current stock/shareholdings. It capitalizes a part of distributable reserve in retained earnings to bring:

(1) share capital more in line with the assets employed; and

(2) a high share price back to a more manageable amount, thus seemingly enhancing its marketability.

In the case of bonus issues, at least the company has been making money and has substantial retained earnings over the years. Although the number of shares held by each shareholder increases, few investors realize that the value of the total shareholding remains the same as before the bonus issue. Where does the extra value comes from, the sky?

Share split is quite like bonus issues, but by splitting say a RM1 par value stock to five 20 sen par value stocks, with 5 times more shares outstanding. Unlike bonus issues, the company doesn’t even have to have retained earnings, or accumulated earnings from the past to split the shares, and woosh, one share becomes 5 shares, and you can sell for the same price money falls from the sky and investors become 5 times “richer”!

Rights issue involves shares being offered to existing shareholders at a discount to the current trading price, for the purpose of raising funds for the company. In Dayang’s case, the company obviously needs immediate money of the appropriate amount from the rights subscribed for lowering its gearing and for working capital, etc., and hence the Rights Issues.  

Dayang’s Rights issue is being sold at a deep discount of 92 sen per share while the share now is trading at about RM1.90. Rational investors of Dayang should subscribe to the rights or otherwise their shareholding will be diluted, and they will lose out. If they do not wish to subscribe the Rights Issues, they should sell their existing shares now.

Private placement does the same purpose as the Rights Issues except that the shares are offered to institutional investors or high net-worth individuals, normally closed to the management at a discount. Private placement could dilute the shareholding of the existing shareholders, and hence they will normally lose out. However, it is a faster exercise with minimal regulatory requirements and shareholders may see long-term gains if the company can effectively invest the extra capital obtained and ultimately increase its revenues and profitability.

Warrants are long-term instruments that also allow shareholders to purchase additional shares of stock at a discounted price, but they are typically issued with an exercise price above the current market price to provide opportunity for shareholders to convert the warrants to ordinary shares within a fixed period of time up to 10 years. Warrants are usually offered “free” in conjunction with right issues and act as a “sweetener” in Bursa.

But if the company requires immediate additional capital right now, warrants may be issued at a price, on top of the conversion price, like the case of Jaks Resources last year which the warrants were sold at 25 sen a piece . If warrants are issued free, no money is collected now. Money is only collected a few years down the road when the warrants are converted. By then the company may not even need the money. This will defeat the purpose of issuing the warrants now.

Effect of corporate exercises to shareholders

Bonus, and share split, Rights issues and warrants (when converted) will cause a company’s net profit to spread over a larger number of shares. In other words, a company’s earnings per share will decrease as earnings allocated to each ordinary share an investor has invested in will be diluted. In general, existing investors given the bonus shares, subscribing for the rights will get their same share of the profit of the company just like before the exercises. No value is created, except, the company has to pay fee to investment bankers.

Before you jump in buying the shares when company announces the corporate exercises, let us look at a couple of serial givers of freebies and other corporate exercises and their subsequent long-term share price performance after the announcement of corporate exercises.

EAH

Table 1: Corporate exercises for EAH

In a span of 8 years from 2010 to 2018, EA Holding, EAH, had carried out 8 corporate exercises in bonus issues, rights issues and free warrants as shown in Table 1 above. This is equivalent to one corporate exercise a year! In the last few corporate exercises, it even gave bonus issues when its share price was trading at below 10 sen! Incidentally, most of the freebies were in free warrants.

I am pretty sure investment bankers love this company very much and very happy about it as they would have collected a lot of consultant fee from EAH helping the company to do all those exercises.

But more importantly, are their long-term shareholders happy?

Figure 1 below shows its share price performance for the last 8 years.

Figure 1: Share price movement of EAH

The adjusted share price of EA Holding has dropped from about 15 sen eight years ago to close at 1.5 sen on 8^th November 2019, for a 90% loss. Most of the free warrants had expired, or will likely to expire out-of-the-money and ended up with zero value.

There were some spikes in the rise of the share price, probably due to the chasing of the share price by the naïve individual investors. The insiders and manipulators, and a minority of short-term speculators who got the perfect timing, were probably happy. But are the long-term individual shareholders happy?

Let’s look at another serial culprit in the game of bonus issues, share split and ‘free” warrants.

Vivocom

Vivocom is as “terror” as EAH. It has changed its name three times and carried out 7 corporate exercises within a period of 6 years as shown in Table 2 below. Many were free warrants too.

Table 2: Corporate exercises of Vivocom

Figure 2 below shows its share price performance for the last 10 years.

Figure 2: 10-year share price of Vivocom

Are the shareholders of Vivocom happy?

I can find an instant when the shareholders were obviously happy. That was when a Rights Issues with free warrants were announced on 2^nd March 2015, by its previous name, Instacom. The share price went up from the adjusted price of 5 sen to 20 sen, for 300% gain within a month. Obviously, that was the time insiders and manipulators jacked up the share price of the underlying shares, in return the price of the warrants, and they distributed all the shares including free warrants given to the big pool uninformed speculators and greater fools. These followers of the greater fool theory were left holding the worthless shares and warrants and continued to stare at the sky.

Subsequently, the share price has been on a downtrend as shown in Figure 2 above. It closed at 1.5 sen on 8^th November 2019, the same faith as that of EAH.

Again, most of the free warrants had expired, or will likely expire, with zero value,

Had shareholder value maximizing occurred for the shareholders with the freebies? Of course, for the insiders, manipulators and short-term speculators. But has any shareholder value created for the long-term shareholders?

Does the management actually care about the long-term investors? As a matter of fact, I am puzzled why anyone wants to be a long-term investor of Vivocom.

Conclusions

Investors love freebies. In many of the AGM, many investors attend just for the free lunch and free coupons for goods and souvenirs. Let me tell you this. They are also coming out from your own pocket, just like the “free warrants”. There are also many attend the AGM and request, or even demand the management for bonus issues and free warrants.

Some freebies did provide handsome returns for the short-term speculators, manipulators and insiders, but do they maximise shareholder value of the long-term investors? Note the gain for those manipulators and insiders has to come from somewhere, where else if not from the large pool of naive retail speculators?

Nothing can be created from the sky. In many cases investors chased the share price up sky high due to the exercises when nothing positive has been created. Eventually share price reverted to what its value is supposed to be, and many new and naive investors lost big time as a result.

Focus on the performance and the value of the business, not these corporate gimmicks and the short-term price movement, you will do better in your investment journey. Avoid all those noises in investing, and you will do satisfactory in your long-term investing journey.

I have written a eBook on how to look at a business and how to value it. These are more important things to pay attention to. If you are interested, you nay email me at,

ckc13invest@gmail.com

The eBook is given out free.

K C Chong