In this occasional series titled JUST ASK, we invite readers to send in questions on stock investing, and personal finance. We will ask an expert (or experts) to provide answers. Below is a series of questions on bonus shares and bonus warrants, and they are answered by Musicwhiz and Ernest Lim - investors whom readers would be familiar with.
Reader: Companies carrying out bonus share issues tend to say that the bonus shares are to reward shareholders. In what ways are they a reward? Or are they just PR talk?
On bonus warrants, I have noted that China Eratat has given such warrants and Best World International is proposing to give out such warrants.
What is the attractiveness of these warrants to shareholders?
Musicwhiz: Dear reader, I don't feel bonus shares are a reward to shareholders. They are akin in substance to a stock split. If I were to be very blunt, I'd call it a marketing tactic to boost short-term interest in the shares of the company.
In other words, Management should just pipe down, grow the business, distribute dividends and then I will be a happy shareholder. I am indifferent to bonus issues.
Bonus issues are simply a form of share dividend, and is similar in substance (though not in form) to share splits. This basically means chanelling some capital reserves to share capital and then issuing these "bonus" (i.e. extra) shares to all shareholders, in the form of an entitlement.
This does nothing to increase the equity base of the company (it's simply the same equity base divided by a large number of shares that's all), and does NOT actually create any value for shareholders. They are left holding more shares, but the share price will adjust to reflect this new reality as the market capitalization of the Company will stay constant (as I said, nothing fundamental changes; it's simply an accounting entry).
As for warrants issued by a company (corporate warrants, NOT structured warrants), they simply offer the right to existing shareholders to subscribe to shares in the company at a discount to market value (at the time they are issued, at least). For example, a company's market price may be $1 but it issues warrants to subscribe for shares at $0.80, and tells everyone there is a $0.20 "discount".
The rationale of these issues is simply to raise money for the company - when you convert the warrant you need to pay the exercise price and they are then converted to shares. This increases the issued share capital of the company and dilutes both earnings and dividend per share.
This is similar to a rights issue in essence as the company distributes these warrants in equal proportions to your shareholdings; the difference is the time to exercise them, that's all. So a shareholder can choose to hold on to their warrants, or sell them in the open market, or convert them to own more shares in the company by coughing up money. Either way, they simply act like rights shares but are different as I had highlighted.
- Musicwhiz is a 30-something investor who has been investing for about 5 years in the Singapore stock market. Accountant-trained, he practices value investing and does his own research into potential companies to invest in. He posts regularly on NextInsight's forum, and writes regularly on his blog http://sgmusicwhiz.blogspot.com/
Ernest Lim: Dear reader, my answers are:
Q1: Companies carrying out bonus share issues tend to say that the bonus shares are to reward shareholders. In what ways are they a reward?
Ans: Bonus shares issues are a reward in the following ways:
a) Reduces the price per share
This is likely to make the share more palatable to retail investors. For example, if an investor only wants to invest S$2K, he would be able to buy a share worth S$1.50 (after bonus), instead of S$3.00. In addition, ceteris paribas, it will be easier for him to “make money” on a stock which is priced at S$1.50, instead of S$3.00 due to price leverage.
b) Increases the float and liquidity
A stock which is extremely illiquid is unlikely to have a huge investor following. This is because after the market crash in 2008/early 2009, investors realise they have to bear illiquidity risk in their consideration as prices for illiquid assets can collapse rapidly in times of distress. Therefore, the increase in float and liquidity bodes well for the stock and the existing shareholders.
c) Signalling mechanism
This can also be a signalling mechanism by the management as they are optimistic that they can service the enlarged share capital. Typically, companies which issue bonus shares maintain their dividend per share at least for the next year. This can be seen in companies such as ARA Asset Management Limited and Techcomp Holdings Limited which assure investors that their dividend per share should be maintained (barring unforeseen circumstances as always) despite the enlarged share capital.
Q2. On bonus warrants, I have noted that China Eratat has given such warrants and Best World International is proposing to give out such warrants. What is the attractiveness of these warrants to shareholders?
Ans: In my opinion, there are two advantages.
a) Immediate: can sell for a quick profit
Assuming that you have sufficient existing shares to be allotted a sizeable quantity of warrants, you would be able to sell the warrants for a quick profit in the market. This is also based on the premise that there is liquidity in the warrants.
b) Future: Ability to participate in future growth of the company
Warrants also provide an “option” to existing investors to augment their equity participation in the company. Typically, warrants would be issued out of the money to existing investors and these warrants have a few years to maturity. If the company is doing very well in the next few years, it is likely that the share price will rise above the warrant price and investors would have the option to exercise them and gain more exposure to the company. This is based on a simplistic assumption that the share price will definitely rise above the exercise price if the company is doing well. There are certainly other factors which will affect the prices of the underlying share and the warrant.
Although it is mostly true that management can reward shareholders in either bonus shares or warrants, and it is likely to be a signalling mechanism for optimism in the company’s prospects, it is also possible that management of fundamentally weak companies are trying to drum up interest in the company before trimming their stake or raising funds. Thus, as always, there is “no one size fits all” analysis in a company. Investors would have to do their due diligence to decide whether it is beneficial for them.
- Ernest Lim previously worked as an assistant treasury and investment manager. Prior to this role, he was with Legacy Capital Group Pte Ltd, a boutique asset management and private equity firm, as an investment manager since 2006. He recently became a remisier. He received a Bachelor of Accountancy (Honours) from Nanyang Technological University in 2005. He is a Chartered Financial Analyst, as well as, a Certified Public Accountant Singapore.
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