Though stock warrants have typically been associated with financial services firms, namely banks, you can occasionally find exceptions out there in the market. One of the most prominent of those exceptions would be General Motors Company (NYSE:GM), which issued warrants subsequent to its Chapter 11 bankruptcy restructuring. There are currently three outstanding issues of warrants in total representing the right to purchase roughly 318.18 million shares of common stock, which is about 19.8% of shares outstanding. This obviously represents a significant portion of shares outstanding to a much higher extent than other warrants. In terms of dilution, there has been debate as to whether the dilution factor should be accounted for when calculating the value of the warrant. Some argue that doing so is incorrect because the market has already accounted for potential dilution, and this is represented and will continue to be represented by the current and future share price. Personally, I lean toward the latter argument because I'm inclined to assume that large institutional investors, who get paid exorbitant amounts of money to know what they're doing, are aware of and take into account the effect of the warrants on share dilution and, by extension, share price. So for the purpose of this analysis, we'll assume that the market has priced in the potential dilution.
There are currently three outstanding issues of GM warrants. Class A, Class B, and Class C. Simple enough, right? The terms for each of the warrants is listed below in order of expiration date as opposed to alphabetically.
|GM WS C||GM WS A||GM WS B|
|Exp. Date||Dec. 31, 2015||July 10, 2016||July 10, 2019|
|Years Until Exp.||1.333||1.858||4.858|
As for exercise price and shares purchasable per warrant adjustments, none of the GM warrant issues include provisions to account for ordinary cash dividends. This will place GM warrantholders at a disadvantage to the stockholders, but in the case of the A and B warrants, which both trade at essentially no premium to the common stock, it would seem as though this is priced into the warrants.
There's no question that GM has had a bumpy ride (get it?) since emerging from bankruptcy and going public in 2010. After a stellar run up from July 2012 to December 2013 (more than doubling), the stock has given up quite a bit of ground among concerns over the plethora of recalls so far this year. But, for those who are interested in the long-term prospects of the stock, these setbacks present an excellent buying opportunity when you consider the 16% pullback since its December highs.
To estimate future share price at the time of expiration, we'll take into account EPS forecasts starting at $4.53 for FYE 2015, which then grows 10% annually. Then we'll assign a conservative 10x earnings multiple to the 2015 estimates, which then increases 0.5 points each year. In reality, that number could be significantly higher, considering that the industry average P/E multiple is currently north of 14; but I think it's best to remain conservative in this situation. We'll also assume that dividends remain $0.30 per quarter through 2015, which then increases $0.05 per quarter at the beginning of each new year.
|Warrant||Exp. Date||EPS Estimate||Earnings Multiple||Share Price||Cumulative Dividends||
Stock % Gain (including dividends)
|Class C||Dec. 31, 2015||$4.53||10||$45.30||$1.50||21.9%|
|Class A||July 10, 2016||$4.76||10.25||$48.79||$2.20||32.8%|
|Class B||July 10, 2019||$6.33||11.75||$74.38||$7.30||112.7%|
These are certainly some excellent gains on the common stock, but how do the warrants stack up?
Warrant Returns Relative To Common
To calculate the intrinsic value of the warrants, all we have to do is take the price of the common stock at the time of warrant expiration, and then subtract the strike price of the warrant.
|Warrant||Stock Price By Exp.||Strike Price||Intrinsic Value||Current Value||Warrant % Gain||Stock % Gain|
Compounded annually, the returns for the warrants would be as follows:
If the assumptions that we've made prove true, then we would see extraordinary returns on the warrants. The Class C warrants offer the most leverage, but they expire in a relatively short amount of time and still trade $3.91 out of the money. If you are an unequivocal short-term bull, and you're positive GM stock will be trading north of the Class C break even price of $43.92 by the end of 2015, the Class C warrants are appealing. Personally, I'm more attracted to the Class B warrants for a few reasons: 1) It has the longest time until expiration - nearly 5 years. 2) There is essentially no time premium built into the warrants. 3) They trade deep in the money. The Class A warrants have characteristics 2 & 3, but again, I'm attracted to the time cushion that the Class B warrants offer.
If you think GM is cheap, as many investors do, you'll surely want to consider going the warrant route. The Class A and B warrants offer extremely cheap leverage for more cautious investors, while the Class C warrants offer considerably more leverage for those seeking it. In any case, all warrants run the risk of expiring worthless under the wrong conditions, so please keep that in mind before making a decision.
Disclosure: The author is long GM.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may initiate a long position in GM Class B warrants (GM WS B) over the next 72 hours.