Thursday, March 6, 2008

On Private Placements and Warrants

Well, just last week I started buying into some stocks, two specifically, both ones that had been discussed in my investment class, and, after I'd done some more research, appeared to be good buys. One is First Majestic Silver Corp (TSX:FR), a small silver mining company that is rapidly developing mines in Mexico. The other is Wavefront Energy and Environmental Services (TSX-V:WEE), a company that has developped a patented technology for better distributing fluid injected underground - the major upshot of which is being able to extract significantly more oil from depleted wells.

Yesterday, both of them made announcements that had to do with private placements, and warrants, so now seems as good a time as any to share what I've learned about those.

What is a private placement?
Since this blog is about being a beginner in the investment world, and I'm expecting any readers (should there be any) to also be beginners, some explanation is in order.

Essentially what happens is that new shares are created and sold to raise capital. It's not a public offering, you have to be invited to get in on it, and usually that only happens to people and companies with deep pockets. Additionally, most private placements include warrants.

So, then, what's a warrant?
A warrant is a type of options, and from the holder's perspective is a lot like a call. They allow the warrant holder to buy a share at a fixed price for a fixed amount of time. The difference - aside from warrants being free as part of a placement - is usually the length of time, and the source of the shares. When you buy a call on the options market, usually the longest ones expire in 6 months, while warrants are typically good for 1-3 years. Then, when you exercise a call, you are just buying existing shares from someone else, and they lose money on the deal, whereas if you exercise a warrant, new shares are created by the company and sold to you...meaning that even though you're probably buying them at below market value, the company still raises extra capital when they're exercised.

Some warrants are traded on the markets as well.

Make sense?

And what happenned yesterday?
Yesterday, First Majestic announced that they were entering into a private placement with several underwrites, including CIBC World Markets, Blackmont Capital, Cormark Securities, and GMP Securities. They will sell those two companies a total of 8.5 million shares at $5.35 per share. One warrant will be issued for every 2 shares, with a strike price of $7, and good for 2 years. Before this announcement, FR had been trading at $5.65...great news for me as I'd bought it last week for $5.10.

So what's it mean...basically it seems to mean that I'm not rich enough to make the serious money. More specifically, what it means in the short term is that the stock will likely decline...that's a lot of extra shares out there diluting the value of the company. I'm not sure how low it will go, it opened this moring at $5.14, and has hovered around there for a few hours so far. Only one trade was below my own buy in, at $5.07, so I may be alright. Also, the effects of warrants are interesting. In my class, we've looked at a couple of stocks with outstanding warrants, and what seems to happen is that the big players who hold the warrants start shorting the stock when it hits their strike price, causing the stock to drop, because they have insurance that they won't lose money on the deal if other trading manages to counteract the short. Since the strike price is $7, this would still be a significant profit for me, so I'm not all that hard done by. However, when I got into FR, I was expecting it to be a quick turnaround...maybe a month or so, as it was significantly undervalued and looked poised for a breakout. Now I'm expecting to have to hold for several months to see the gains I wanted.

With Wavefront, the event was almost the exact opposite. Wavefront had previously concluded a private placement, and has outstanding warrants as a result. Their announcement was that because their 20 day, volume weighted average closing price was above $1.50/share, all warrants - which had previously had expiry dates of either Dec. 24, 2008, or January 31, 2009 - had to be exercised within 30 days.

I'm new at this, so exactly what this one means required a bit of research. Essentially, it's a good thing, because removes the warrants from circulation, which, as previously discussed, allows big players to play with the stock price with no risk. Share dilution - the new shares created when existing warrants are exercised - already shows up on the financial statements, so the share price should already be taking into account the existence of these shares. So, the effect of this should be negligible or good. And today's results seem to confirm my understanding, as the stock is continuing to slowly increase.

On the chart below, you can see the overnight effects of this news:

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