Red Flag / Green Flag
There are red flags and there are green flags for stock investors. A few obvious ones on the positive are director stock buying, raised profits guidance, raised dividends, and perhaps something which has been evident of late, a stock price holding at or above a placing price. On the negative side, florid language regarding the outlook, a referral to revenues rather than profits, and no management skin in the game (stock) are among the many.
But what has been and is still evident is the way that the colour of some stock market flags can be confused in terms of whether they are in the plus or minus column. Ironically, stock options and the mathematics being them are generally accepted as a good thing.
The recent example of Catenae Innovation (CTEA) is an outstanding case in point. The shares were hovering just below 4p at the end of July when the CEO and CFO were granted options on some 15m shares. What was intriguing is that the vesting criteria, i.e. the price at which they had the right to buy portions of the 15m shares started at 10p, and on to 20p, 30p, 40p, and 50p. Each level had to hold for 15 consecutive days above the 30 day volume weighted share price, so no flash in the pan spike would do the trick.
There were two takeaways from this. First that the management at Catenae clearly has high hopes for their company. Second, if the stock rallied enough for them to get their hands on the stock, after a 10 bagger move, few would quibble, not least existing shareholders. This is even though, unlike warrants, the result of options being exercised does not bring significant money into a company as no new shares have been issued. When it does this tends to be at a much lower level than the prevailing price when the exercise takes place.
Indeed, when most investors read about options deals in an RNS, it is not taken as a negative as it is assumed that if holding the stock they will be aligned to the person exercising the option. Indeed, as options can often disappear if the option holder leaves the company, they are much more of an incentive tool than warrants. Here, when it is known warrants have been issued to a stock buyer, or someone funding a company a rather negative fog seems to descend on the parties concerned. For instance, the company must be desperate to issue the warrants, and the counter party is somehow exploiting the situation. However, just as in the markets there is a buyer for every seller and vice versa, there is another way of looking at this. Once again, there are a couple of recent examples which illustrate the case.
On June 19 Eqtec (EQT) announced:
“Warrants over 14,400,000 New Ordinary Shares at a price of 0.25 pence per share together with warrants over 191,000,000 New Ordinary Shares at a price of 0.375 pence per share have been exercised. The aggregate gross proceeds of these exercises receivable by the Company amount to £752,250.”
The previous week some £200,000 of warrants had been exercised, after the share price had quadrupled from below 0.2p in just a few weeks. As well as the stock uplift, Eqtec now had nearly an extra £1m in the bank. The new stock creates a dilution effect, but only when the stock price rise has more than compensated for it.
The W Word
On the other side of the deal, Riverfort (RGO) one of the parties issued with warrants as part of its funding package for Eqtec, as disclosed last week, made a swift £90,000 having sold the shares converted from its warrant exercise at a 92% profit. So, it really was a win-win, illustrating that in many ways the W word is not a bad one, but as close as possible to being the perfect stock market instrument.
The Warrants Windfall
Warrants effectively enable funding situations where other risk / incentives might not be sufficient to get them over the line. This will have and no doubt, will continue to make the difference between companies rebounding – especially now post Covid, and falling by the wayside. For instance, funding a company with £500,000 even with a 12% coupon may sound attractive initially, but not if you are concerned that it may not have the means to repay the debt. However, having say, the equivalent of 30% of the loan in warrants as well can change the risk / reward of the deal. The lender can then balance the fortunes of this arrangement, with other deals in the portfolio and make it work.
Finally, warrants may also provide a message to those of a bearish inclination, trying to find the next domino to fall. For instance, while Eurasia Mining (EUA) was knocked incessantly as being low on cash at the start of the year, some of the doomsayers clearly did not factor in the windfall the company received as a result of its share price rise from under a penny in October to 7p in February. Its “warrants windfall” came through in as those holding them from around 1p were able to cash out. The result was £300,000 in the bank to Eurasia, a state of affairs made all the better for all concerned given the current stock price near 20p, and arguably a contributor to the rally. A similar victory was delivered to Verditek (VDTK) last week, as its warrants windfall also netted £300,000 to the company.
Once again, bears of the stock seemed to miss this fact when attempting to determine the financial position of a company. A warrants can make the difference between a company being a “short” or a buy. It will be interesting to see if Verditek follows a similar mega bear squeeze path to Eurasia thanks to its “warrants windfall”.