Sunway’s attractive warrant with step-down mechanism

Sunway Bhd (July 31, RM4.28)

Maintain buy with an unchanged target price (TP) of RM5.04: Sunway Bhd issued a circular with more details of the proposed bonus issue and free warrants. To recap, Sunway had proposed four bonus issues of shares for every three existing shares and three free warrants for every 10 existing shares. The above proposals were approved by Bursa Malaysia Bhd on July 24 and an extraordinary general meeting will be held on Aug 30 to secure shareholders’ approval.

Compared with ordinary free warrants, we opine that Sunway’s free warrants are attractive as the first-of-its-kind fixed annual step-down mechanism of seven sen will enhance the value of the warrants.

For ordinary warrants, a dividend entitlement on the underlying mother share would reduce the value of the warrants. However, with the step-down mechanism (which is akin to a fixed adjustment of dividend payments to underlying), the value of the warrants would be unaffected (if the quantum of step down is equal to the dividend).

In the case of Sunway, given the annual step down of seven sen, the estimated value of the free warrants is 62 sen (post-bonus issue adjustment) based on a binomial options pricing model, representing a premium of 34%. However, the estimated value of the warrants could be as high as 73 sen if based on our TP of RM5.04.

Note that the step down of seven sen is higher than our projected dividends for financial year 2018 (FY18)  and FY19 at 4.6 sen and 4.9 sen (post-bonus issue adjustment) per share respectively.

The higher quantum of step down compared with dividend projections could further enhance valuation of the warrants.

We gather that while Sunway has no immediate plans to utilise the proceeds (approximately RM1.15 billion assuming full conversion) from the conversion of the warrants. Hence, any proceeds raised will be used for future working capital or deleveraging. — Hong Leong Investment Bank Research, July 31

This article first appeared in The Edge Financial Daily, on Aug 1, 2017.

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