Waiter: Do you want to slice your pizza to 5 pieces or 10 pieces?

Me: No, 20 pieces please. I am very hungry.

Of late, many companies in Bursa carry out corporate exercises such as bonus issues, share split, right issues and free warrants. Note that the companies carrying out these exercises require the service of investment bankers and the fees are not cheap. But do these exercised enhance shareholders value?

Bonus is 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. Although the number of shares held by each shareholder increases, the value of the total shareholding remains the same as before the bonus issue. Cutting a pizza into 5, 10 or 20 pieces doesn’t increase the amount of food to be consumed, does it?

Rights issue involves shares being offered to existing shareholders at a discount to the current price, for the purpose of raising funds for the company. It is a way to raise capital. Capital is raised when investors pay for the new shares that are being issued. Companies can use the raised capital to acquire assets, make a take-over, repay debts or save themselves from bankruptcies. Rights issues however are sometimes issued by companies with healthy balance sheets in order to fund research and development projects or to purchase new companies.

Of course, a company can raise capital by other ways, such as borrowing from banks or issuing bonds, redeemable preference shares etc. However, there can be times where the banks and investors may be reluctant to lend, especially if the company is not doing well. In addition, high interest rate incurred by loans or the issuance of bonds and other securities may also force a company to raise capital through rights issue offering.

Bonus and Rights issue 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. However, capital raised through rights issue can further strengthen the company’s balance sheet and allow it to pursue strategic opportunities in core markets.

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 in conjunction with right issues and act as a “sweetener” in Bursa.

After the announcement on the Bonus and Rights Issue, and free warrant, the shares will be trading on a “cum” basis. As long as an investor purchases the shares while they are trading on “Cum” basis, the shareholder will be eligible to receive the Bonus Shares and subscribe to the Right Shares as declared by the company. Once the shares trade on “ex” basis, an investor who purchases the shares will no longer be eligible to receive the Bonus, right Shares and Warrants as declared by the company. Rights are often renounceable and investors can sell off the Rights after the ex-date for a period of about 1-2 weeks before expiry of the Rights.

Investors’ Reactions

Investors generally are happy with the bonus issues and chase share price up before and after the announcements. Why not as investors seem to get more shares without having to pay anything, is it?

Let take a look at my portfolio discussed in the following link and see the effect of bonus issues on share price movement:

 http://klse.i3investor.com/blogs/kcchongnz/56926.jsp

Three out of ten stocks declared one for one bonus issues; they are Prestariang, Pintaras and Jobstreet after the posting of my portfolio on 23^rd January 2013. Let us see the reactions on the share prices of Pintaras and Prestaring from 1^st January 2013 to 30^th June 2015 before and after the bonus issues were announced on 30^th July 2013 and 20^th February 2014 respectively.

Figure 1 and 2 below shows that prior to and after the announcement, the share price of Pintaras Jaya and Prestariang went up and continue to run up for a long time.

But why were the share price of Pintaras and Prestariang ran up and continue to run up with the announcements when bonus issues do not create any additional value as we argued above?

Let us look at another famous or should I say notorious company which has been carrying out these exercises all the time, not that its share price was high and the company wanted to make the shares more liquid. Table 1 below shows the numerous corporate exercises carried out by EAH as extracted from the Bursa website.

Table 1:

During the last 5 years, there were 5 such corporate exercises; bonus, rights and free warrants. Have all these exercises added shareholder value? They don’t seem so as the adjusted share price of EAH has dropped from 36 sen 5 years ago to just 12 sen at the close on 30^th June 2015 as shown in Figure 3 below.

Why is there such a big difference in the corporate exercises of Pintaras Jaya and Prestariang compared to that of EAH? Why were the share price of Pintaras and Prestariang performing so well compared with that of EAH with the same corporate exercises?

I postulate that it is not the corporate exercise which adds value to a company, rather it is the “unlocking” of the true values of Pintaras Jaya and Prestariang as a result of the corporate exercises. Those two companies were great companies selling at cheap price before the bonus issues and few investors realize their values before that. I have done numerous analysis and published in i3investor to show my investment thesis on Prestariang and Pintaras. Furthermore they are debt free companies and with plenty of cash in their blance sheets. And who says companies with no borrowings but plenty of cash and cash equivalent won't do well?

I have also done some simple analysis on EAH before when a popular local investment blog highly recommended investing in EAH using the rationale that EAH was able to acquire great businesses (while others can’t?) for its great future growth, and I never believe that EAH was so good that others wanted to sell great businesses to it at cheap price and not to other more established and more credible companies. To me this company is more concern about spending money and doing those useless corporate exercises which do not add value, rather than focus on improving their business performance.

The worst is when the announcements were made, small time retail investors chased the price and bought high, and major shareholders distributing their shares and the share price eventually fell back to oblivion. Thi I believe is the frequent case.

Bonus issues and free warrants for Homeritz

Here is another stock which I am holding announcing a two for one bonus and four for one free warrant on 5^th May 2015.

HOMERITZ CORPORATION BERHAD

1) Bonus issue of 100,000,000 new ordinary shares of RM0.20 each in Homeritz Corporation Berhad ("HCB") ("Bonus Shares") to be credited as fully paid-up on the basis of one (1) Bonus Share for every two (2) existing ordinary shares of RM0.20 each held in HCB at 5.00 p.m. on 7 July 2015.

2) Issuance of 50,000,000 free warrants in Homeritz Corporation Berhad ("HCB") ("Warrants") on the basis of one (1) Warrant for every four (4) existing ordinary shares of RM0.20 each in HCB held at 5.00 p.m. on 7 July 2015.

The share price of Homeritz ran up from about RM1.00 from the date of announcement to RM1.42 at the close on 30^th June 2015, or 42% gain in less than 2 months as shown in Figure 4 below:

Again I would argue that no extra value was added but the corporate exercise merely “unlocks” the value of this unpopular stock with the bonus and free warrants issues, as few investors pay attention to an unexciting stock such as Homeritz.

The above Company’s securities will be traded and quoted “[Ex-All]” as from 3^rd July 2015 with the last date of lodgement on 7th Jul 2015.

The important question is, what is the likely and reasonable ex-dated price of Homeritz? What will be the reasonable and theoretical price of its new warrants?

If the adjusted price of Homeritz and warrants is such and such, is it advisable to hold them, buy more or sell?

We will discuss these stuff in the next article.

K C Chong (1^st July 2015)

ckc14invest@gmail.com