Compared to the convertible bond, the share subscription warrant appeared relatively late in France. It was not until the law of 03 January 1983 authorising the issue of bonds with share subscription warrants (OBSA) that it appeared. Subsequently, the law of 14 December 1985 was to authorise the issue of shares with share purchase warrants (ABSA) and of autonomous warrants.
What is a stock purchase warrant?
A share purchase warrant (Warrant) is a security giving its holder the right to subscribe to shares of a company at a fixed price and for a specified period of time. It is a negotiable financial instrument that can be listed on a stock exchange.
The share subscription warrant may be issued by the company independently of any other issues: we speak of autonomous warrants or they may be attached to securities (shares or bonds) issued by the company: ABSA or OBSA.
Four elements make it possible to characterize a warrant from a financial point of view: the share underlying the warrant; the subscription parity, i.e. the number of shares required to obtain a share; the period during which the warrant can be exercised (very exceptionally it can be a date); the price at which the shares can be subscribed.
So how does it work?
As far as its operation is concerned, the holder of share of purchase warrant is not required to exercise his warrant, but only has the option to do so: it may be expected that he will so decide if the share price exceeds the exercise price during the exercise period.
Finally, the bearer shares delivered to the holder who exercises are new shares, which implies the completion of a capital increase by the issuer.
What interests to acquire or issue share warrants (BSAs)?
For the issuer: They allow a company to carry out a deferred capital increase in cash when the warrants mature. The use of the warrant allows shares to be issued at a higher price than would be possible during a normal capital increase even if the cash inflow is delayed.
The issuance of warrants is also an opportunity for the company to give a signal to the market on confidence in the evolution of prices. Vouchers can be a loyalty bonus for shareholders. And finally, the issuance of an autonomous share subscription warrant for an anti-takeover function.
For the investor: The acquisition of a warrant allows its holder to benefit from any speculative gains. The acquirer’s motivation is generally financial, i.e. to benefit from the capital gain effect that can be offered by an exercise price considered low in relation to the possibilities of appreciation of the underlying security. Like tradable options and financial warrants, warrants can be used to boost the profitability of a stock portfolio.
Risks related to the issue of share warrants: the risks are of two kinds and are due to unfavourable changes in the conditions for exercising the warrants:
The share price may first of all not keep its promises and never exceed the exercise price before the end of the exercise period. The voucher will not be lifted. Therefore, the capital increase that was planned with the exercise of the warrant will not take place; it is a question of a generally sudden disappearance of the issuer’s equity resources that it will have to face.
The second unfavourable scenario is when the share price rises very sharply. The exercise price will be significantly exceeded and the good exercised. The holders of the warrants will receive a significant capital gain and the capital increase will take place.
In all cases, a reason for dissatisfaction will remain for the issuer: the enrichment of warrant holders will be counterbalanced by the impoverishment of former shareholders who do not hold warrants, who may blame the company for its lack of foresight in defining and calibrating the issuance of OBSAs or ABSAs.
Risks related to holding equity warrants: first of all, it is a fairly high volatility of the warrants as soon as the share price approaches the exercise price; this instability makes it difficult to hedge by purchase/sale of underlying assets. The holder also exposes himself to the risk that the share price will never exceed the exercise price and thus lose his entire investment.
Finally, in most cases, it is exposed to a liquidity risk: the warrants are of course specific to each issue and can under no circumstances be assimilated to pre-existing warrants; their number is therefore always limited to the size of the issue, which is often reduced because of the issuer’s desire not to be overexposed with a conditionally significant capital increase.
Source: Financial, Tax and Legal Engineering 2006/2007 (DALLOZ ACTION)