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Corporate Governance

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Step 4- Warrants

Next check on Warrants issued to promoters or higher management. 

Q: What are warrants? 

Stock warrants are just like call options on the common stock of the company. It gives the holder of the warrant the right to buy new shares issued by the company at a fixed price by paying 25% of the exercise price upfront. The remaining 75% must be paid on the date of exercise, not exceeding 18 months from the date on which the warrants were issued. The average share price in the last six months is taken into account while determining the exercise price of warrants. The price payable at the time of exercise is predetermined irrespective of the current market price of the share. If the promoter fails to pay the balance amount within the stipulated time period, the warrant expires.

The issue of Stock warrants to promoters can be interpreted in many different ways. In the case of companies that are undergoing severe liquidity issues, capital infusion by the promoters is generally taken as a positive sign. Lenders are happy with whatever amount the promoters bring as fresh equity to the company. The additional infusion gives them security as they would be able to recover a larger amount in case the company defaults.

Many times, warrants are issued to promoters at a steep discount to the current market price putting minority shareholders at a disadvantage. It might also happen that the promoter has some insider information that can significantly influence the stock price. The promoter can make huge paper gains by subscribing to the warrants before such information is made public. He might also exercise his warrants after the announcement of such news & sell his shares in the open market.

An investor would acknowledge that the shares issued via warrant allocation are subject to a lock-in-period of three years. Nonetheless, the promoters own a large chunk of the already existing shares of the company. Hence, it becomes possible for the promoter group to safely pocket the notional gains on shares received via warrant allotment by selling the existing shares of the company.

Promoters prefer to increase their stake via warrants as compared to open market transactions. The reason behind this is that promoters buying from the open market garners a lot of attention & pushes up the stock price of the company. However, in the case of warrants, the exercise price is fixed irrespective of the market price of the stock

In our opinion, any warrants are a speculative tool possessed by insiders. If the company is facing a liquidity crunch & lenders are unwilling to provide loans, then the board can even raise funds through a rights issue. This method will provide the company with funds in a much shorter span of time. Also, it will give other shareholders a level playing field to protect their stake from dilution. It has been observed time & again that the promoters are unwilling to subscribe to the warrants if the share price of the company falls considerably below the exercise price. Many opportunistic managements took advantage of the recent market crash to issue warrants at prices much below the fair market value.

Analysis of Sagar Cements:

Quick Snapshot: (Data as of Closing Prices on 17th February, 2021)

We have spent a good amount of time in our lessons learning to spot the red flags. Let us now shift our attention to one of the best-in-class promoters who have oftentimes proved their mettle.

Consistency thy name:

Profit & Loss (Consolidated Figures ₹ Crores)

The revenue & profitability momentum of the company is a rare-feat for a small-cap company operating in a cyclical sector with excess capacity. The data speaks volumes about how committed the promoter is in scaling up the business.

What caught our eye:

"Pursuant to the approval accorded by you at the Extraordinary General Meeting held on 8th January 2019, your board had allotted 31,00,000 warrants at an issue price of 730/- per warrant. Each of these warrants was convertible at the option of the warrant holders concerned into 1 equity share of 10%-each at a premium of 720 per share within a period of 18 months from the date of allotment of the said warrants. Your company has raised a sum of 226.30 Crores through the above allotment and the same is being utilized, inter-alia, for investment in the subsidiary companies to part fund the setting up of a fully integrated green field cement plant of 1 MTPA capacity in Madhya Pradesh and a grinding station of 1.5 MTPA capacity in Odisha"

Page 65, Annual Report, FY 2019-20  

The warrants were priced at ₹730 apiece, an over 14% premium over the stock's closing price of ₹639.95 on 16th January 2019. When share warrants are issued at a premium, it gives confidence to minority shareholders that the management would put in extra efforts towards creating value for all. 

As discussed earlier, the warrants issued to the promoter group are valid for a period of eighteen months from the date of allotment. The promoter had already subscribed to 15,50,000 shares on 24th July 2019.

 In an intimation to the stock exchanges on 27th March 2020, the company informed:

'"We wish to inform you that the Securities Allotment Committee of our Board has today allotted 3,25,000 shares of Rs.10/- each at an issue price of Rs.730/- per share (including a premium of Rs.720/- per share) to M/s. R.V.Consulting Services Pvt. Ltd., an entity belonging to our promoter group, against conversion of similar number of warrants, earlier allotted to it pursuant to the approval accorded by our shareholders at their Extra-ordinary General Meeting held on 8th January, 2019 "

Further on 24th July 2020, the company informed:

"We wish to inform you that the Securities Allotment Committee of our Board at their meeting held on today has allotted 12,25,000 equity shares of Rs.10/- at an issue price of Rs.730/- per share to the entities belonging to promoter group and others, against conversion of similar number of warrants, earlier allotted to them, pursuant to the approval accorded by our shareholders at their Extra-ordinary General Meeting held on 8 th January, 2019. In this connection, we further wish to inform you that with this present conversion, the process of conversion of the entire 31,00,000 warrants earlier allotted on 24th January 2019"

Let us check the stock price of the company on both these dates:

27th March 2020- ₹300
24th July 2020- ₹448.70

As a matter of fact, the stock hit its 52 week low of ₹236.30 on 23rd March 2020. 

Some alternate courses of action:

a) The promoter could have issued the warrants at a steep discount to the market price on 16th January 2019 i.e. ₹639.95

b) The promoter could have simply forfeited the balance 15,50,000 warrants it had not yet subscribed. It had paid ₹182.5 per share i.e. 25% of the issue price for it. Next, the board could have come up with another issue of stock warrants at a much lower price. It would have resulted in substantial savings nonetheless as ₹300+182.5 amounts to ₹482.5 vs the issue price of ₹730.

c) If the actual intent of the promoter was only to raise his stake at the cost of minority shareholders, he could have also resorted to buying from the open market & choose not to subscribe to the remaining 15,50,000 warrants. 

This is precisely why it is said that management integrity is tested in tough times like these. Liquidity was a real issue back in the day & everyone believed the market could fall further. Yet, the promoter showed faith in his company & invested more to fund these acquisitions at a time when the entire industry was apprehensive of the demand cycle returning to normalcy. Remember, The money in question here was the promoter's personal funds & he was under no obligation to subscribe to the remainder warrants. 

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Units 15/19