YTLPower- rallying on cheap warrant issue

YTLPower has proposed a RM2.2 billion convertible bond issue that comes with detachable 10-year warrant, which would be offered to its shareholders on the basis of 1 warrant for every 3 shares held. The exercise price of these warrants was fixed at RM1.25 (or, a discount of 48.8% to the 5-day weighted average market price of the share up to April 21st). The ex date for this entitlement falls on May 13th. This ex date was announced on April 28th. Like clockwork, the share price immediately jumped up (see Chart 1 below).

Is this price rise justifiable? Like Bonus Issues, Share Splits & "discounted" Rights Issues, this "discounted" warrant issue should impact the valuation of the share. So, I believe that the improved share price is a short-term phenomenon and the share price will adjust downward after this issue. How much adjustment in the share price after the warrant issue?

To do this, let's assume that we have a 1-for-3 warrant issue at an exercise price of RM2.50; share price cum rights of RM2.50 (ignoring current price fluctuation); and, warrant's conversion premium of 20%. On this basis, warrant's market value will be 50 sen (i.e. no intrinsic value, only conversion premium). The share price ex rights will be unchanged at RM2.50. So, a person with 3 shares cum rights who go through the exercise will end up with 3 shares (worth RM7.50) & 1 warrant (worth 50 sen). In total, his investment in YTLPower is now worth RM8.00.

Back to the proposed YTLPower's warrant issue. Everything remains unchanged, except for the exercise price that is now pegged at RM1.25. The share price ex rights should be lower because some of its value will be now "transferred" to the deeply-discounted warrant in the form of intrinsic value of RM1.25. Since the warrant issue is a 1-for-3 issue, this intrinsic value will be shared out between 3 shares. Assuming that his investment in YTLPower is also worth RM8.00 after the exercise, we can derive a formula to compute the value of the share & the warrant as follows:

[3 X Share value] + [1 X Warrant value] = 8.00
[3a] + [(a-1.25) + (a X 20%)] = 8.00
3a + a - 1.25 + 0.2a = 8.00
4.2a = 8.00 + 1.25
4.2a = 9.25
a = 9.25/4.2
a = 2.20

So, share value ex rights is about RM2.20 & warrant value is about RM1.39. Of course, in the real world, everything fluctuates & the actual value could vary by 10-20 sen from this computed value. The share value ex rights of RM2.20 seems to fall within the channel in which YTLPower share price is moving, albeit on the lower boundary (see Chart 2 below).


Chart 1: YTLPower's daily chart as at May 2, 2008 (courtesy of Quickcharts)


Chart 2: YTLPower's weekly chart as at May 2, 2008 (courtesy of Quickcharts)

In conclusion, I do not believe YTLPower's current price rally is anything exciting, nor something worth trading. The only interesting thing about this exercise is the question on everyone's mind- Why does YTLPower want to raise RM2.2 billion cash when it is sitting on RM7.6 billion cash reserves?