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Brief Summary: 86% discounts to market placements are not "signals" of expectations of rapidly rising stock prices, in my opinion they are signals of desperation!
I believe the analysis offered by Sankar Acharya is somewhat deficient in that rather than answering the question I had asked, eg, "what is the value of the warrants?" the writer choose to ignore the question and moved on. I had not intended to post anything on this topic, but since the Acharya chose to post my private correspondence to him, without seeking or obtaining my permission to do so, I will respond in this public forum at this time.
I believe that Acharya's central premise is that the placement of equity by SYQT is a "signal" that the buyers have expectations of future share prices being substantially above current share prices. What I would propose and illustrate is that in the alternative, this buyer can be generally unconcerned about the ex-post future appreciation of SYQT shares and still be certain to make a substantial profit on his investment. There are a couple of different strategies that will allow this to occur which can be discussed at some length. Careful inspect of the terms of any placement of securities can provide a signficant "signal" of the quality of the firm seeking capital. Much like a consumer in seach of a loan to purchase a car, the track record and prospects for the customer can greatly affect the interest rate charged. A top rated, wealthy individual with sterling credit may borrow funds for as little as 6 or 7%, on the other hand, a shiftless casual laborer with a history of poor payment of bills, and poor future prospects may find himself paying upwards of 36%! The analogy to SYQT is purposeful and direct.
A starting point is to look at what a standard "deal" costs to place. A firm of SYQT's size if it was in reasonable financial shape could expect to place $30 or $50 million in a public secondary offering and expect to incurr costs in the range of 5 to 6% of the gross amount placed. Careful evaluation of the specific terms of the SYQT placement allows for calculation of the "fee" or discount required for issuance and provides a signal of the huge gap in quality between the SYQT offering and an "average" secondary offering. The absolute magnitude of the discount in the case should in my view taken as a clear "signal" that the buyer views SYQT common stock as extremely risky and has demanded a commesurately huge risk premium in compensation thereof. In my writing on this topic in the past year on the AOL forum I had demonstrated that in a number of placements in the past year or so, SYQT had implicit costs of capital in these transactions in the range of something like 90 to 100%! Clearly such a risk premia is a signal that should be carefully observed and interpreted, much like entities such as Mecury Finance have learned that there you attract a lot of dead-beat customers when you make car loans at 36%.
Analysis of the Current SYQT Transaction Part 1:
On August 4, 1997 SYQT issued 1,382,716 shares, gross price $3.5 million, gross price per share $2.53 the market Price of SYQT share on thedate prior to issuance (price is similar on day prior to and after placement date as well)
Date Volume High/Ask Low/Bid Close
-------- ---------- ---------- ---------- ----------
08/01/97 1,971,600 2 15/16 2 1/2 2 9/16 <=== trade day (t -1)
08/04/97 8,389,600 3 5/16 2 3/4 3 1/8 <=== placement date
08/05/97 5,993,300 3 1/8 2 11/16 2 15/16
08/06/97 2,200,600 3 2 3/4 2 3/4
Giving SYQT the benefit of the doubt and assuming that the closing price from 08/01/97 was used to determine the share price, the shares were issued without discount or premium prior to consideration of the critically important value of the warrants.
The value of the warrants is actually fairly simple to estimate and is central to determining the "signaling" properties of the placement. It is tautological that the buyer assumed the warrents to have value, surely if he assumed them to be worthless they would not have become part of the transaction. But one must be carful to avoid confusing an ex-ante expectation of a higher price for SYQT common with an ex-post realization thereof. Cleary ex-ante the warrants can be shown to have substantial value even if ex-post SYQT common stock never exceeds the initial placement price. Should one not wish to dwell on the mathematical requirements of theoretical option pricing models, may I just assume a common sense approach? Think for yourself, today, how much would you pay for a warrant that allowed you to purchase a share of SYQT anytime in the next 7 years for a price that will not exceed $3.05 REGARDLESS of what SYQT is trading for? Would you $.50 for such a warrant? How about $1.00? How about $2.00? Understand that if you personally estimated that warrants to be worth $1.00 that is equivalent to SYQT having issued the stock in this transaction at ZERO! If you valued the warrants at $.50 that is the same as SYQT having sold the stock to JayHawk for $1.27 a share or a discount to market of 32%.
Now let us move on to the Black Sholes pricing of the warrants. Determining the value of the warrants provides an insight into the steep transaction discount that was required in order to place the equity. Let us try some basic values:
stock price on date of issuance: $2.53
Strike Price of warrants: $3.05
Time: 2500 days (7 years)
Risk free rate for 7 years: 6% approximately
Volatility: Observed values ofSYQT Implied volatility in last year 100% to 200%, trial values used 100%, 50% and 25%.
Option Pricing Model used online:
dailystocks.com
Volatility, I do not have access to the official Bloomberg measure. The standard approach taken to estimate the volatility is to plug in the values for existing options and solve for the implied volatility. Choosing 4 different SYQT options in the last year has yielded Volatilty measures between 96% and 212%. Three values will be used for purposes of illustration, one with a Volatility of 100% and two with very conservative estimates of 50% and 25% to fully illustrate the range of possibilities.
Based on these measures Black Sholes shows prices for the warrants of ($2.09, $1.38, $.87) (100%, 50%, 25%) each, multiplied by the 3.5 million warrants issued as part of the package, the warrants would be assigned a B-S value of ($7,315,000,
$4,830.000, and $3,045,000). Obviously the dominant portion of the transaction regardless of the volatility assumed IS the warrants NOT the stock! Let us use the most conservative estimate for the remainder of the analysis and assume a volatility of .25.
Taking the total proceeds of the transaction of $3.5 million and subtracting the $3,045,000 B-S value of the warrants leaves a cost of $455,000 to be assigned to the 1,382,716 shares of common issued, or $$.33 per share!. or a discount of 86% of market value. Cleary the discount implied by this analysis and to my view the very conservative assumptions used demonstrates the extreme risk premium demanded by the buyers of this placement. I welcome alternative quantitative analysis that either supports or refutes this contention.
Let me suggest one strategy that has been employed in these types of placements at other entities as reported in Barrons in April of this year. Barrons has reported that certain firms use offshore entities to simultaneously short the number of shares purchased in the placement and receive the same price for the shares in the long position. At this point the firm has a net investment of ZERO in the firm, the short position is a complete hedge of the long shares and the investor has no cash invested or committed. Theoretically what the SYQT holder would have at zero cost is a seven year option to purchase SYQT share s for $3.05 each. Let us consider the likely binary states of nature that can obtain:
State 1: The buyer believes correctly SYQT stock will never exceed $3.05 in price and therefore maximizes his return by selling the warrents as soon as possible to receive the largest time-value possible. Based on the previous calculations this would result in a net profit of perhaps $3 million for the 11 month holding period on a net investment of zero or an infinte rate of return.
State2: The buyer has a correct expectation of an appreciated share price and holds the warrants to the optimal point and then sells resulting in a profit at least as great in State 1.
As you can see there is almost no downside to the buyer, and in fact there is an almost guaranteed profit of something on the order of $3 million, regardless of the eventual outcome.
In summary, a careful analysis of the facts of the placement transactions to my view does not provide any signficant reassurance of upwardly spiralling share prices for SYQT.
The huge gap between average secondary placement costs of 6% and SYQT's observed 86% discount to market inherent in this placement should provide significant credible evidence of the riskiness of the firm and of SYQT's inability to place capital in anything approaching "normal" terms of doing business. |
