Saturday, January 12, 2013

Olam Bonds plus Warrants Offer - To take or not to take for Retail Investors?

I was on annual leave travelling Europe for the last couple of weeks and was too busy since being back earlier this week to make any decent postings. Oh my, how much has the stock market rallied in my absence and how Olam made tremendous amount of headlines during the Nov-Dec period.

Being a  retail shareholder of Olam (vested), I received the thick bond and warrant offer booklet outlining all the details of this terribly complicated offering. 

  1. 5 year bonds +
  2. 3 year European warrants and then 2 years of American style warrants +
  3. USD denominated exchange rate risk (USD down, bond coupon and maturity payment when converted to SGD down // USD down, warrants cost down, capital gain increase)
  4. Trade-ability of bonds and warrants only in 1,000 units boardlot on SGX which makes odd lots difficult to dispose of.
  5. (And in addition) Newspaper reports of people suggesting that the offer is really good and hence likelihood that the offer might be fully subscribed leaving little odd lot conversion possible.
Anyway, that's the simple qualitative analysis. 

Below is another simple quantitative analysis that I have came up with to aid my decision making process
Assumptions to calculations are
  1. Based on purchasing 1932 bonds + 1,000 warrants (162:313)
  2. Hold bonds to maturity (5 years lock-up)
  3. Sell warrants immediately after 3 years lock-up
  4. USD/SGD stays at 1.2273 level throughout 5 years
  5. Calculations include ~S$28 brokerage fee to sell exercised warrants
  6. Calculations factor in dilution factor in Olam share prices right after this offering assuming that ALL warrants are exercised and the company adjusts the warrant strike price accordingly in future dilution exercises to maintain the same spread.
  7. Total annualised returns = (1 + Gain from 5 year bond coupons + US$0.05 bond discount after maturity + Gain from Warrants sale)^(1/5years) - 1

I think that to be putting in ~S$2,300 (for 1932 bonds) and taking the risk for 5 years, the minimum annualised returns that I expect from this investment be at least 6%. This is based on my own risk and target investment profile. In order to achieve this, the table simply tells me that I would require Olam stock price to appreciate by at least 30% in 3 years. So now, if you believe such is possible, then this subscription does make some appetizing sense.


I also repeated the same analysis above to find out the sensitivity of USD/SGD exchange to this investment gain. The additional assumption is fixing analysis based on 
  1. 20% gain in Olam share price (changing to 50% gain on Olam share price does not make the exchange rate sensitivity any greater)

As shown, the obvious fact is that exchange rate does little to impact total annualised returns. For the nitpickers, the weaker the USD, the better the gain becomes. And for analysis sake, the USD has been on a downward slide against SGD in the last 5 years due to weaker economic fundamentals and huge monetary stimulus (devaluation). However, in end 2013 the Fed has suggested an easing of the monetary stimulus with growth recovery in sight so expect some support at near current USD/SGD levels for the next 2-3 years.

In a nutshell, this offering ties Olam to the shareholders of the company for the long-term (at least for retail investors who may find it difficult to unlock value of bonds/warrants in the bond/warrants market). If you believe in the stock fundamentals that there is nothing wrong with being overaggressive in capital investment of late, that the company will return to positive cashflows in 2013-2014 after investments start to realise potential, that Olam has the liquidity in place to ride out any more storms, that the commodities market will make a timely rebound to push its stock prices up, then I would say this investment makes sense.

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Anonymous said...

I do think your analysis can not be right. The bond yield alone is higher than 6%, so how could that Olam share price does nothing, can result a yield of 1.5% only given that you paid nothing for the warrant, you can just let it expire worthless?

healthytrader said...

Hi, the assumption as mentioned is to sell the warrants after 3 years. So 0% change in Olam stock price (after dilution) 3 years from now ($1.6 without dilution of the new warrants; $1.34 with dilution) will represent a $0.285 loss on the strike price of $1.626 (assumption that USD/SGD stays at 1.227).
Of course, you are right to say that you can let the warrants expire and not incur any loss on the warrants part. This is also subject to the assumption that the analysis is based on holding extra rights ie. one does not have any existing Olam shareholdings as dilution would have caused a capital loss should you not exercise your share of warrants 3-5 years later. Therefore, if you should hold shares right now and are considering this offer, then if you choose not to exercise your warrants in future, it is tantamount to accepting another loss too. If not, then your reasoning holds perfect sense and that probably gives us an idea to why the rights may be oversubscribed by people without the base holdings in Olam.

Anonymous said...

As in your assumption, have you mentioned anything related to loss incurred on Olam share itself? if that's the case, the least you can do is to state a price Olam should be based on, then evaluate accordingly. I wonder how you arrived the yield in your table based on your assumption of unknown Olam share price(??). If it is purely based on the bond and warrant itself, there is no way, the yield is that low in your table.

No matter how, I don't see a loss from the warrant itself. If the market price is lower than the exercise price, the rational way of no-dilution will be buy from open market, instead of exercising the warrants.

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