Bonus Warrant Offering flaws Raising Capital

Generally small mining or exploration companies rely on brokers for raising capital. Conditions of the public or limited offering often affect the share price thoroughly. An incentive frequently applied is the offering of a bonus warrant for a given number of shares purchased. This seriously flaws share price behaviour during or even after the capital raising. Eventually the warrant incentive turns into a proper investement purpose whereby subscribers sell shares or short them in advance.

Quite evidently the market price quickly drops below the subscription price of the offering. How investors value the bonus warrant accounts for the difference. Such warrants differ from regular options on a few key points:

• warrants are not always publicly tradable,
• warrants generally have a strike significantly above the offering share price,
• at offering, warrants typically are valid for over one year,
• special clauses may force warrant execution (such as the share price quoting over a certain threshold above the warrant strike for a given number of days);

I examined the recent offering of Formation Metals (FCO) by Jennings as the main broker. New shares are issued at CAD 1.60 (one needs to do the math, as the press release only mentions totals). A warrant is offered for every second share purchased. Warrants allow purchasing an extra Formation Metals share at CAD 2.00 for one year to come. What’s the value of such a warrant?

As a comparison I checked the option price of the January 2011 series of SSRI, a mining share with comparable volatility. The call option with strike about 25% above the current share price trades for about 8 % of that share price. The longer validity of the warrant (12 months against 10 for the option) may offset intrinsic disadvantages of the warrant. As such a fair share price for FCO could be around 4 % below the offering price or close to 1.54. Investors having bought well above that price on TSX have been providing the free lunch for slick speculators eager to stash fresh warrants for little money.

FCO dropped significantly below that 1.54 level last few days as it became clear that the offering had little success. Adverse cobalt prices and a lack of marketing effort of the broker eventually made Formation Metals change course on their financing plans, as the offering was withdrawn.