Buying warrants vs. buying stocks

QUESTION: My question is about warrants, specifically the 1933 Industries (CSE: TGIF) warrants. I have read a lot about their low relative cost and long expiration dates. I'm new to warrants and wondered if you could talk about buying the warrants vs. the stock.

B.C. from Vancouver, Canada

ANSWER: In the investment world, a warrant is a financial security that gives the owner the right (not the obligation) to buy an underlying security under specific terms and conditions including exercise price, quantity and expiry date. Warrants are almost always issued in a unit with another security in a financing. Warrants are added to an offering as a “sweetener” that makes the offering a little more attractive for prospective investors. Warrants can be listed and trade just like a stock if they are detachable from the underlying security. Other warrant terms include, for example, what is called a forced conversion or accelerated exercise clause. Under this clause, the issuer can effectively force the exercise of warrants under certain conditions defined at the time of issue. A warrant that has an underlying security price above the exercise price is said to be “in-the-money.” If the underlying security price is below the exercise price, the warrant is said to be “out-of-the-money.”

You asked about a low relative cost and long expiration dates. Under certain circumstances, a warrant can be similar to a call option. If you’re looking for such a warrant, the two characteristics I would look for:

1. 1. A low relative cost can be benefit an investor in two ways. First, if you find a stock trading at $30 with a warrant trading at $3.00, then 1,000 shares will cost you $30,000 whereas 1,000 warrants to buy 1,000 shares will cost, say, $3,000. Second is price leverage. If the price of the stock goes up 10% which is not an unreasonable expectation, it will go from $30.00 to $33.00 per share. If that happens, your warrant might go from $3.00 to $6.00 for a 100% return. Of course, leverage is a two-edged sword. So there will be a similar impact on the warrant price if the underlying stock price should decline. If the price of the stock fell in half from 30.00 per share to $15.00 per share, it would be down 50% while the warrant price might decline to effectively zero.

2. 2. A long expiry date is valuable because the worst case long term outcome is your warrant is out-of-the-money on the expiry date. So the longer you have for your warrant to trade in-the-money, the better off you are.

To cash in an in-the-money warrant, assume there is an exercise price of $1.00 and a market price of the underlying common share of $2.00. To cash in you have to cover the exercise price amount first. If you own 10,000 warrants, the company will issue you 10,000 new shares at $1.00 per share. If the shares are trading at $2.00, the shares you received are worth $20,000. But to exercise 10,000 warrants to get those 10,000 common shares at a $1.00 per share you need $10,000 cash. The 10,000 warrants and the $10,000 cash enables you to exercise your warrants to receive 10,000 shares.

You asked about TGIF so I will use it as an example. TGIF has a warrant outstanding with the following terms: one warrant plus $.65 allows you to purchase one common share of TGIF on or before September 14, 2021. TGIF can force the exercise of this warrant if TGIV stock trades at a price of $.70 or more for 10 consecutive days on the Canadian Stock Exchange. This is an out-of-the-money warrant right now.

This TGIF warrant came as part of a unit with a convertible debenture offering in August 2018. Warrants are often issued along with an offering of common shares. Sometimes the unit will include only one-half a warrant. In that case you will need to combine two half warrants to buy one share.

Finally, you must not let the expiry date pass without exercising your in-the-money warrant. In this TGIF warrant, on Tuesday, September 14, 2021 (the time of day can also be critical), any warrants not exercised will probably have significant value. On Wednesday, the warrant will have expired and be worthless.

If warrants remain outstanding until expiry date and the underlying security performs well, warrant holders will likely have exercised fairly evenly over time and the short term impact of the securities markets will be negligible. But when the warrant conversion is accelerated as they have been with 1933 Industries (Khiron did the same thing recently), then the exercise of all the warrants involved is compressed into a few weeks. People who don’t the cash needed to exercise, often sell the underlying stock to raise the money. When they get additional shares from exercising, the holding in their portfolio will increase again.

Because experienced investors have seen stock rebound quickly after being artificially depressed by an accelerated warrant exercise. That is why I have been consistent in seeing a decline in a stock’s price following an announcement of an acceleration of a warrant expiry.

If life was only so simple. Everything I said above might be true but after a company announces an acceleration in a warrant expiry, the price of the stock does not go down. In such cases it could be the stock price is not below where it was trading but it is below where it would have been trading if the acceleration had not taken place.

This could easily be the case with TGIF. After the Company announced the accelerated expiry of some series of warrants, it announced a non-brokered private placement of 10,000,000 units made up of shares at $.45 per share and a full warrant exercisable at $.75 per share to raise $4.5 million. It was subsequently announced the offering was fully subscribed by one placee, Mr. Paul Rosen who is described as a career entrepreneur, management consultant. Rosen is more than that in my opinion. He is a co-founder of PharmaCan Capital that subsequently rebranded to Cronos Corp (TSX: CRON) (NASDAQ: CRON) that accepted a significant investment from Altria (NYSE: MO) Rosen is a founder and former CEO and Chairman of Tidal Royalty (CSE: RLTY.U) and sits on the board of directors of iAnthus Capital (CSE: IAN), Hill Street Beverages (TSXV: BEER) and High Tide Ventures (CSE: HITI). I believe the added credibility that Paul Rosen brings to TGIF by making this investment means that when the selling of TGIF common shares to exercise under the accelerated plan dries up in the next ten days we can expect a smart bounce in the stock price,