Author: kcchongnz | Publish date: Thu, 6 Aug 2015, 08:10 PM
"When you locate a bargain, you must ask, 'Why me, God? Why am I the only one who could find this bargain?'" - Charlie Munger
The followings are the conversations I have had with an e-friend in i3investor just three weeks ago.
Posted by paperplane2 > Jul 12, 2015 03:12 AM | Report Abuse
If now I spot an opportunity to arbitrage to gain near 30%return, shall I do so in big scale?
Posted by kcchongnz > Jul 12, 2015 10:38 AM | Report AbuseX
I highly doubt you have any risk free arbitrage opportunity. If you are talking about risk arbitrage which is likely the case, then you have to view each circumstance.
Posted by paperplane2 > Jul 12, 2015 06:13 PM | Report Abuse
Technically it is called risk free when you have warrant in discount. As you can convert and sell the mother soonest. Provided of course you can convert fast.
Posted by kcchongnz > Jul 12, 2015 07:09 PM | Report AbuseX
This is definitely a risk arbitrage, unless you can short sell the underlying stock. I call it execution risk. The advantage of it is your potential gain as you said is high at 30%, quite a wide margin. However anything can happen before the whole conversion exercise is carried out and completed, probably in two to three weeks’ time. I got burned before many years ago when a similar situation happened on a stock and its warrant call Country Height with the cunning and manipulative major shareholder and manager. So watch out who is behind the company, if he is trustworthy. It is hard to find a big fat frog jumping all around nowadays.
This would be what I am going to do after getting the tip from this friend. Let us take an example of a public listed company, Asdion Berhad.
Asdion Berhad (Asdion) is a Malaysia-based investment holding company engaged in software development and information communication technology (ICT) and related activities. The Company, specializes in providing integrated operations software solutions and products, which focuses on service sectors from hospitality, recreational, supply chain logistic to travel related businesses. Operations are carried out in Malaysia, Singapore, Brunei and China.
The thesis
First I would examine the investment case of Asdion warrant. Asdion has 113 m common shares and 52 m warrants outstanding as at 31st March 2015. It has RM3.7 m debts, cash of RM2m and hence a net debt of RM1.7 m. Book value per share is 20.4 sen, way below its share price of RM1.50 then.
The profile of the warrants is as below:
The warrants still has a long expiry date of four and a half years, and hence a good time value on top of its intrinsic value. As on the date of conversation three weeks ago, Asdion was trading at about RM1.50 and the warrant at about 70 sen. This means the warrant has an intrinsic value of RM1.00. It was hence traded at a discount of 30 sen, not including the huge time value it is supposed to have. This is what you can do then:
You short sell 100000 shares of Asdion at RM1.50 and get RM150000 and use the proceeds to buy 100000 shares of its warrant at 70 sen. You then immediately send the warrants for conversion by paying 50 sen per share, or a total of RM50000. Three weeks have passed now and you can pass the converted share to the buyer of your short sale of Asdion shares. You pocket a clean RM30000 without coming out with a sen, ignoring the minor transaction costs. How nice!
The theory of arbitrage is very powerful in finance and investment. However, there are limitations. The constraint here is you cannot sell Asdion, unless you have already own them, or someone is willing to lend to you. If you do not have any Asdion shares in this case, you have to put out your own money of RM70000 to buy Asdion W at RM0.70 apiece, send them for conversion by paying another RM50000, and now you probably have just received your converted 100000 shares of Asdion.
This is clearly a risk arbitrage with the execution risk. The risk is when I get back my converted Asdion shares, will the share price of Asdion still remain the same for me to profit?
Clearly I have my doubts on the above after bitten once many years ago with this Country Height warrants mentioned in my conversations above. I have great reservation of this market place.
Financial performance
I will next look at its past financial performance, at least I know if Asdion is good company and if I get caught and have to hold the shares for long term investment, it is still okay. I know investment is about the future and some savvy investors would scorn me for looking at the rear view mirrors. It is no use reading audited accounts. No use knowing how to read balance sheet, or cash flow, so they say. They are all history. The company is a high tech company. It has great plan for the future and this time is different. But I am just different. I read history and place a lot of weight on it before I start investing.
Figure 1 below shows the past 5 years performance of Asdion. Every year it loses a few million Ringgit, and even more than RM10m in 2012 for a small service company. So what is the story?
Historical share price movement
Next I better look at its recent share price movement to have a clue of what is going on. Figure 2 below shows that Asdion share price has been around 40 sen to 60 sen for a long period of time until a year ago when its share price suddenly jumped from that tight range to RM1.60, a more than 100% jump in share price within a year. Hence there must be some kind of momentum, so I must buy the shares now or else I would miss out this golden opportunity. Buying the warrant with a gearing of more than two times and at a big discount to its intrinsic value, besides its free time value, is even better. One sure would make big money!
But again, it is me. I don’t chase the share after it has gone up so much in such a short time, especially for a company which has been losing money for so many years. I am not a follower of the greater fool theory. So as usual, I passed this golden opportunity.
Moral of the story
Asdion and its warrant closed at RM1.11 and 49 sen respectively on 6th August 2015. If one has bought the warrant at 70 sen three weeks ago and sent for conversion to the underlying shares with 50 sen per share, he is able to sell it now at RM1.11, for a loss of 9 sen, or RM9000 for 100000 warrants bought, not that bad. For those who have bought it but have not sent for conversion, the paper loss is 21 sen, or a whopping loss of 30% in just three weeks, instead of a gain of 30%. They would still wonder whether to hold them and hope its share price would recover, send for conversion with RM50000, or just sell them off to realize the big loss of RM21000. The decision is not an easy one.
The moral of the story is, “there ain’t no tooth fairy in Bursa”. In fact, Bursa is full of traps set up especially for manipulating the retail investors. I would be surprised if anyone hasn’t been deceived before falling into those traps.
There is only one way you can prevent yourself from falling into the traps and becoming the victim; equip yourselves with all the knowledge of finance and investing. Learn the language of the business of which you want to hold part of it. Read widely from the writings of true super investors, and gain experience from them. Do not believe anyone has the altruistic intention to make money for you by giving you share market tips.
There is no free lunch in this world.
K C Chong (7th august 2015)
The followings are the conversations I have had with an e-friend in i3investor just three weeks ago.
Posted by paperplane2 > Jul 12, 2015 03:12 AM | Report Abuse
If now I spot an opportunity to arbitrage to gain near 30%return, shall I do so in big scale?
Posted by kcchongnz > Jul 12, 2015 10:38 AM | Report Abuse
XI highly doubt you have any risk free arbitrage opportunity. If you are talking about risk arbitrage which is likely the case, then you have to view each circumstance.
Posted by paperplane2 > Jul 12, 2015 06:13 PM | Report Abuse
Technically it is called risk free when you have warrant in discount. As you can convert and sell the mother soonest. Provided of course you can convert fast.
Posted by kcchongnz > Jul 12, 2015 07:09 PM | Report Abuse
XThis is definitely a risk arbitrage, unless you can short sell the underlying stock. I call it execution risk. The advantage of it is your potential gain as you said is high at 30%, quite a wide margin. However anything can happen before the whole conversion exercise is carried out and completed, probably in two to three weeks’ time. I got burned before many years ago when a similar situation happened on a stock and its warrant call Country Height with the cunning and manipulative major shareholder and manager. So watch out who is behind the company, if he is trustworthy. It is hard to find a big fat frog jumping all around nowadays.
This would be what I am going to do after getting the tip from this friend. Let us take an example of a public listed company, Asdion Berhad.
Asdion Berhad (Asdion) is a Malaysia-based investment holding company engaged in software development and information communication technology (ICT) and related activities. The Company, specializes in providing integrated operations software solutions and products, which focuses on service sectors from hospitality, recreational, supply chain logistic to travel related businesses. Operations are carried out in Malaysia, Singapore, Brunei and China.
The thesis
First I would examine the investment case of Asdion warrant. Asdion has 113 m common shares and 52 m warrants outstanding as at 31st March 2015. It has RM3.7 m debts, cash of RM2m and hence a net debt of RM1.7 m. Book value per share is 20.4 sen, way below its share price of RM1.50 then.
The profile of the warrants is as below:
| Maturity Date: | Mar 24, 2019 |
| Issue Size: | 52,191,260 |
| Exercise Price: | MYR 0.50 |
| Ratio: | 1 Warrant : 1 Ordinary Share of RM0.10 each |
The warrants still has a long expiry date of four and a half years, and hence a good time value on top of its intrinsic value. As on the date of conversation three weeks ago, Asdion was trading at about RM1.50 and the warrant at about 70 sen. This means the warrant has an intrinsic value of RM1.00. It was hence traded at a discount of 30 sen, not including the huge time value it is supposed to have. This is what you can do then:
| Action |
Share
|
No of shares
|
Price
|
Amount
|
| Sell |
Asdion
|
100000
|
1.50
|
150000
|
| Buy |
Asdion W
|
100000
|
0.700
|
-70000
|
| Convert |
Asdion W
|
100000
|
0.500
|
-50000
|
| Profit |
30000
|
You short sell 100000 shares of Asdion at RM1.50 and get RM150000 and use the proceeds to buy 100000 shares of its warrant at 70 sen. You then immediately send the warrants for conversion by paying 50 sen per share, or a total of RM50000. Three weeks have passed now and you can pass the converted share to the buyer of your short sale of Asdion shares. You pocket a clean RM30000 without coming out with a sen, ignoring the minor transaction costs. How nice!
The theory of arbitrage is very powerful in finance and investment. However, there are limitations. The constraint here is you cannot sell Asdion, unless you have already own them, or someone is willing to lend to you. If you do not have any Asdion shares in this case, you have to put out your own money of RM70000 to buy Asdion W at RM0.70 apiece, send them for conversion by paying another RM50000, and now you probably have just received your converted 100000 shares of Asdion.
This is clearly a risk arbitrage with the execution risk. The risk is when I get back my converted Asdion shares, will the share price of Asdion still remain the same for me to profit?
Clearly I have my doubts on the above after bitten once many years ago with this Country Height warrants mentioned in my conversations above. I have great reservation of this market place.
Financial performance
I will next look at its past financial performance, at least I know if Asdion is good company and if I get caught and have to hold the shares for long term investment, it is still okay. I know investment is about the future and some savvy investors would scorn me for looking at the rear view mirrors. It is no use reading audited accounts. No use knowing how to read balance sheet, or cash flow, so they say. They are all history. The company is a high tech company. It has great plan for the future and this time is different. But I am just different. I read history and place a lot of weight on it before I start investing.
Figure 1 below shows the past 5 years performance of Asdion. Every year it loses a few million Ringgit, and even more than RM10m in 2012 for a small service company. So what is the story?
Historical share price movement
Next I better look at its recent share price movement to have a clue of what is going on. Figure 2 below shows that Asdion share price has been around 40 sen to 60 sen for a long period of time until a year ago when its share price suddenly jumped from that tight range to RM1.60, a more than 100% jump in share price within a year. Hence there must be some kind of momentum, so I must buy the shares now or else I would miss out this golden opportunity. Buying the warrant with a gearing of more than two times and at a big discount to its intrinsic value, besides its free time value, is even better. One sure would make big money!
But again, it is me. I don’t chase the share after it has gone up so much in such a short time, especially for a company which has been losing money for so many years. I am not a follower of the greater fool theory. So as usual, I passed this golden opportunity.
Moral of the story
Asdion and its warrant closed at RM1.11 and 49 sen respectively on 6th August 2015. If one has bought the warrant at 70 sen three weeks ago and sent for conversion to the underlying shares with 50 sen per share, he is able to sell it now at RM1.11, for a loss of 9 sen, or RM9000 for 100000 warrants bought, not that bad. For those who have bought it but have not sent for conversion, the paper loss is 21 sen, or a whopping loss of 30% in just three weeks, instead of a gain of 30%. They would still wonder whether to hold them and hope its share price would recover, send for conversion with RM50000, or just sell them off to realize the big loss of RM21000. The decision is not an easy one.
The moral of the story is, “there ain’t no tooth fairy in Bursa”. In fact, Bursa is full of traps set up especially for manipulating the retail investors. I would be surprised if anyone hasn’t been deceived before falling into those traps.
There is only one way you can prevent yourself from falling into the traps and becoming the victim; equip yourselves with all the knowledge of finance and investing. Learn the language of the business of which you want to hold part of it. Read widely from the writings of true super investors, and gain experience from them. Do not believe anyone has the altruistic intention to make money for you by giving you share market tips.
There is no free lunch in this world.
K C Chong (7th august 2015)
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