Long term stock warrants could be big multibaggers

As part of my investing strategy one thing that I keep a close vigil on is to be on a look out long term warrants that any of the companies that I hold issues. Typically 4-5 year equity warrants are multibaggers in their own ways. I would explain this concept with the help of an example relating to the Trent 2010 warrants.

Now this specific warrant states that in 2010 (or earlier in case of rights issue) the warrant holders shall have the right to convert their warrants into equity for Rs 650 per share. This warrant trades very thinly and I did buy quite a few in July and August near to Rs 210 levels. The trading was and continues to remain very thin and I had to put in several days to get some decent quantity.

Now assuming that Trent would show an EPS growth of 35% the 2010 EPS for the company should be Rs 67.00. If the market were to discount that by 30 times the stock would trade at Rs 2000 in the year 2010. Here comes the effect of the warrant:

Now I have assumed a 35% EPS growth for Trent which is very conservative considering the kind of growth plans the company is into. In case the company does a 40% CAGR in EPS the equation will change into.

Key Highlights:

1)      The warrant acts as leverage and multiplies the wealth by more then 3 times compared to the original stock.

2)      Higher the company growth higher the gains from the warrant

3)      In this case the warrants are covered in case the company comes out with Bonus/Splits.

4)      The only threat is if the company comes out with a very liberal Rights issue at a very cheap price (nearer to face value). This will reduce the market price of the share (Ex-Rights) without affecting the warrant conversion price.

5)      In case of (4) above warrant holders have the right to exercise premature conversion of warrant into equity share.

6)       In case of (4) above the returns could be affected to some extent.

7)      Warrant holders will not get any dividends which we will ignore since the yield is not that high for Trent..

8)      The promoters hold warrants in their capacity so they would not do anything to adversely jeopardize the interest of the warrant holders.

9)      Most importantly one has to be bullish on the original stock.Higher the intrinsic value (Price of Stock - Rs 650) in the price of the warrant higher would be the margin of safety.

Overall all companies do keep issuing warrants from time to time and serious long term investors should make a bid for those warrants and pick them up. Some years back Tata Motors issued some warrants and at that time I did not know that these warrants were could be such significant instruments of wealth creation.

Conclusion: In Trent’s case the Present value of the conversion price of each warrant Rs 650 for a little more then 3 years (early 2010) @ 8.5% interest works out to Rs 500.

Therefore the easiest way to see whether the price on the screen makes sense is to deduct Rs 500 from the market price. For instance if the market price is Rs 880 the price of the warrant should be Rs 880 – Rs 500 = Rs 380. The margin of safety is the discount to this price that the warrant is bought at finally. The present Rights issue announced by the company should set the price back by Rs 50 so we may deduct that from Rs 380. That leaves us with Rs 330 as the fair value of the warrant as on date.