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Why keep MRCB Wa kcchongnz

kcchongnz
Publish date: Wed, 21 Jan 2015, 03:47 PM
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This a kcchongnz blog

“How about MRCB warrant?”

The above question was asked by a participant of my course yesterday after I posted my article on why I retained BIMB Wa as a stock in MyThirdPortfolio.

http://klse.i3investor.com/blogs/kcchongnz/68735.jsp

This guy must have bought some MRCB Wa the last time I wrote about it here:

http://klse.i3investor.com/blogs/kcchongnz/58419.jsp

He must have the value of his MRCB Wa diminished by about 25% now. However he never complains about me as he knew I was sharing of knowledge and the buying of the warrants was solely his own call and he took responsibility of that gracefully.

I would like to respond to his above question as below.

Why did I bought MRCB Wa in the first place?

 “MRCB and its warrant, Wa is at RM1.68 and 27.5 sen respectively on 22nd August 2014. The exercise price of Wa is RM2.30 and the expiry date is on 16 September 2018, or more than 4 years’ time. The warrant is hence way out-of-the-money with zero intrinsic value. The premium now is 53.3%.” 

“MRCB Wa, with quite a long time to expiry of four years, is trading at an undemanding valuation in terms of premium of 53.3%. Furthermore, it has a high gearing of 6.1 times which would greatly amplify the gain if the underlying share price spikes up before the expiry date.  Hence, if you believe in a company like MRCB as an investment with its various high profile projects, Wa is definitely a good alternative buy.”

What has changed since then?

 

Updated Valuation of MRCB Wa

 

Let us look at the profile of warrants of MRCB Wa below as on 21th January 2015.

 

Share price of MRCB, S:                RM1.34                

Share price Wa, W:                          RM0.205

Exercise/Strike price, X:                  RM2.30

Expiry date:                                         16/9/2018

Conversion ratio:                             1 for 1

 

The computations of the properties of the warrants as shown below:

Intrinsic Value of MRCB Wa = Max [0, S – X] = 1.34 – 2.30 = 0

The warrant is hence way out-of-the-money with zero intrinsic value.

 

Premium P = (W + X) / S – 1

P = (0.205 + 2.30) / 1.34 = 87%

 

Gearing of Wa = 1.34 / 0.205= 6.5 times

 

The warrant is hence still way out-of-the-money with zero intrinsic value. Even with a time decay of 5 months since then, the premium has risen to 87%.  The price has become more expensive than before. The value of Wa is purely in its time value of 20.5 sen given by the market. The gearing is 6.5 times which is reasonably high.

 

So is MRCB Wa still worth investing?

 

Black-Scholes Option Pricing

With the underlying share price at RM1.34 exercise price of RM2.30, 3.7 years to maturity, risk-free rate of 4% and the past one year historical volatility of MRCB at 38%, the option value of Wa is 21 sen. This shows the market price of 20.5 sen is what the option pricing shows. 

 

There isn’t seem to be any margin of safety investing in MRCB Wa based on the theoretical option pricing. Is there?

 

Investing thesis of MRCB Wa

Option pricing model is just a theoretical model based on many assumptions, some are sound, such as value of warrant depends on the volatility of the underlying share price, time to expiry etc, and some are not practical in the real world, such as rationality of investors, lognormal distribution and stochastic behaviour of share prices, constant volatility etc. My thesis on investing in MRCB and its warrant is not so much depending on this theoretical model, but rather what is the prospect of MRCB as a company in the near future which will affect its share price.

 

MRCB was never a favourite company of mine to invest in mainly because I don’t really like to invest in government-linked enterprise. I was attracted by the change of its management to a more proactive and seemingly more credible management. With the gain from the disposal of the Duke Highway and the achievement of several milestones; the resolution of the dispute with PKNS on P.J. Sentral, the entering of the Definitive Agreement with Kwasa Land for the development of MX-1 Land and the completion of the acquisition of the balance 51% equity interest in Penang Sentral Sdn Bhd, transportation hubs and others, there appears to be some excitements in the near future. Its cumulative three quarters results ended 30th September 2014 also showed a turnaround from a loss of 111m the previous financial year to a profit of 158m, or 9.34 sen per share.  Rather than just looking at MRCB itself, I have chosen its warrant for the high gearing of 6 times then.

 

Payoff for MRCB warrant

Table 1 below shows the payoff for Wa for various price of MRCB before expiry of the warrant in less than four years’ time.

Table 1: Payoff

MRCB

1.34

2.13

2.30

2.68

3.00

3.50

4.00

5.00

MRCB

0.0%

59.1%

71.6%

100.0%

123.9%

161.2%

198.5%

273.1%

Wa

-100.0%

-100.0%

-100.0%

85.4%

241.5%

485.4%

729.3%

1217.1%

If the price of the underlying share does not move above 72% to RM2.30, the exercise price, when Wa expires, it will be worthless. Even if MRCB share price doubles to RM2.68, the gain of Wa of 85% is still below the gain of the underlying share. The leverage effect of Wa can only be felt positively if the gain of the underlying share is more than 100%. For example, if the underlying share can move up by 200%, Wa would have gained by 3.6 times to 730%. Figure 1 below shows the payoff of Wa with different prices of MRCB.

Figure 1: Payoff for underlying share and warrant of MRCB

With that, I wouldn’t speculate on Wa with too much money as the underlying share has to go up quite substantially before the power of leverage of Wa is positively felt. I would buy it with financial risk management in mind owing to the potential of its future mega projects.

 

MRCB Wa as a financial risk management

 

Say we just want to “show up” in investing in the prospect of MRCB with about RM10000.  We buy 50000 shares of Wa at 20.5 sen for RM10250. If MRCB share price goes up to my expected price of RM4.00 within this 3.7 years, the intrinsic value of my warrants would be RM85000, and I would make a handsome RM74750. However, if the share price of MRCB doesn’t move at all, I lose only RM10000 in Wa, the maximum of my exposure which is more bearable.

 

Conclusion

MRCB Wa, with 3.7 years’ time to expiry, appears to be trading at a fully valued price of 20.5 sen with a quite a high premium of 87%. It has a reasonable high gearing of 6.1 times which would greatly amplify the gain if the underlying share price spikes up before the expiry date. If one believes in its seemingly plausible growth stories, it may be a viable option to invest in it but with a maximum exposure in mind.  

 

K C Chong (21 January 2015)

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5 people like this. Showing 8 of 8 comments

belkg

Mr kc chong, tks f u write up.currently I do not own any mrcb wa,but hv 1 query what do. U think of our msia mkts?

2015-01-21 17:35

kcchongnz

What do I think about the Malaysian market. I don't know lah. there are many people here who know better than I.


All I know is if a stock is cheap, I buy. Expensive, I sell.

2015-01-21 20:58

paperplane

Hi kc, what do you consider high gearing ratio range. Isnt higher the better. Is multiply effect better.

2015-01-27 08:00

CFTrader

Hi , kcchongz. Do you feel that Black Scholes theory do not quite "suitable" apply in M'sia market ?

2015-01-28 11:54

kcchongnz

Posted by paperplane > Jan 27, 2015 08:00 AM | Report Abuse

Hi kc, what do you consider high gearing ratio range. Isnt higher the better. Is multiply effect better.


Yes, the higher the gearing, the better is the warrant as the higher the potential gain because of the leverage effect. The maximum loss remains the same as your initial outlay

2015-02-01 14:34

kcchongnz

Posted by CFTrader > Jan 28, 2015 11:54 AM | Report Abuse
Hi , kcchongz. Do you feel that Black Scholes theory do not quite "suitable" apply in M'sia market ?

There are two basic kinds of theories; theory on physical matter and theory on finance and investment. Physical theory applies everywhere in the world, and finance and investment theories often do not apply anywhere in the world.

To me,Black-Scholes OPM is just a guide. One can't know the value of something without having a feel of something, can he?

2015-02-01 14:46

Robert Love

I think you have made a fundamental error in all your analysis because you have made the mistake called "the flaw of averages".

E.g. with reference to your article on "Tien Wah Valuation", you assumed that a company can grow certain average rate of growth annually. But, it will never happen in reality!!!

e.g. 3%, 4%, -2%, -5%, 4%, 5%, 5% ---- Growth Path 1

e.g. 2%, 2%, 2%, 2%, 2%, 2%, 2% --- Growth Path 2

The average of the above 2 series = 2% per annum.

If one were to apply the above 2 different path of growth rates to derive valuation for Tien Wah, one would end up with 2 totally different valuation!!!

Welcome to the world of "Flaw of Averages"...

http://flawofaverages.com/

Hope the writer can go and read up on the book "The Flaw of Averages" :)

2015-02-04 21:22

kcchongnz

While I welcome constructive criticism very much, but

1) What is the relevancy of the following comment on MRCB warrant?

2) What has your favorite Tien Wah to do with warrant and its valuation?

3) Which part of my valuation of Tien Wah used the assumption of average growth in the future like this:

3%, 4%, -2%, -5%, 4%, 5%, 5%

4)Which valuation of which stock did I used "average" future growth assumption?

5) Thanks for your great recommendation of your "flaw of averages". Looking at the title I thought do I really have to read the book to know what is the flaw of averages which seems like 1 2 3 to me.



Posted by Robert Love > Feb 4, 2015 09:22 PM | Report Abuse

I think you have made a fundamental error in all your analysis because you have made the mistake called "the flaw of averages".

E.g. with reference to your article on "Tien Wah Valuation", you assumed that a company can grow certain average rate of growth annually. But, it will never happen in reality!!!

e.g. 3%, 4%, -2%, -5%, 4%, 5%, 5% ---- Growth Path 1

e.g. 2%, 2%, 2%, 2%, 2%, 2%, 2% --- Growth Path 2

The average of the above 2 series = 2% per annum.

If one were to apply the above 2 different path of growth rates to derive valuation for Tien Wah, one would end up with 2 totally different valuation!!!

Welcome to the world of "Flaw of Averages"...

http://flawofaverages.com/

Hope the writer can go and read up on the book "The Flaw of Averages" :)

2015-02-05 12:03

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