Non-Financial Warrants - What's Out There?

Includes: DYN, GM, KMI
by: Adam Jones

A variety of warrants that were created as a result of the TARP bailout of US banks are well known and discussed. There are warrants that trade for institutions other than banks though, which don't get a lot of attention - which means there could be chances to buy these under-appreciated opportunities.

Three non-financial companies have warrants that are quite liquid and still have several years until expiration: General Motors (NYSE:GM), Kinder Morgan Inc. (NYSE:KMI), and Dynegy (NYSE:DYN). All three of these companies have recently fallen on company-specific news. The table at the bottom of the article summarizes the relevant information about the warrants.

Warrants have very similar characteristics to call options. They give the holder the right to buy shares at a fixed price on or before a fixed future date. The warrants that the treasury was given in these companies had a 10 year life - so they provide very long-term leverage. Another interesting aspect of these warrants is that the strike price is adjusted downward if a common stock dividend is paid above certain levels.

GM Warrants

There are three series of warrants on GM that currently trade. Each of the three series has different strike prices and expiration dates. This allows investors to choose the level of volatility and the expiration date they want exposure to. The Series A and Series B warrants are in-the-money so they will have lower volatility than the Series C warrant which is out-of-the-money. The Series B warrant has the longest time until expiration while the Series A warrant has the lowest strike price. These warrants do not have a dividend adjustment mechanism.

Here's the prospectus for the Series A and Series B warrants. The Series C warrants were sold to the public at a different time so they have a different prospectus.

The Canadian government recently sold 30 million shares at around $37 per share. Also, the US treasury is in the process of selling out of their large stake entirely. The US treasury plans to finish liquidating their stake in early 2014. This continued selling pressure has kept downward pressure on GM stock. Opportunistic investors can take advantage of the depressed stock price and buy these warrants.

GM is a great fundamental story. They are in the process of shedding their government ownership, which has been a big overhang on the stock since the IPO. Also, the stock is cheap compared to their main US rival, Ford. GM has a PEG ratio of 0.61 against Ford's 0.72. Also, GM's debt rating recently got upgraded to investment grade at Moody's as they announced they are buying back high priced debt.

KMI Warrant

There is only one series of warrant that trades for KMI. This warrant has a strike price of $40.00 and an expiration date of May 25, 2017. These warrants do have a dividend adjustment mechanism but the current dividend is below the tiered adjustment threshold. As part of KMI's purchase of El Paso, shareholders were given these warrants on KMI. There were roughly 505 million warrants initially issued. Since the initial issue, Kinder Morgan has been buying back the warrants so only 348 million are still outstanding.

Here's the prospectus for the warrants with additional information.

Kinder Morgan shares have come under significant pressure recently due to questions raised about their accounting methodology. This drop provides investors who are believers in the company with an attractive entry point. For investors who want leverage in this investment, these warrants might meet the need.

Dynegy Warrant

One series of Dynegy warrants was created when a previous form of the company emerged from bankruptcy. Holders of the common stock of the company during bankruptcy received these warrants which started trading in October 2012. The warrants expire in October 2017 and have a strike price of $40 which is well above the current stock price. As a result, this warrant can be very volatile.

Here's the prospectus for the warrant.

Dynegy has had a rough few years, during which time shares have fallen significantly. Investors who are bullish on the company as it emerges from bankruptcy could look to these warrants as a leveraged way to initiate a long-term bullish position.

Here's a table summarizing the relevant information for each of the warrants discussed above.

GM Series A Warrant GM Series B Warrant GM Series C Warrant KMI Warrant DYN Warrant
Current Stock Price ($) $35.59 $35.59 $35.59 $36.49 $19.67
Current Warrant Price ($) $26.09 $18.40 $3.95 $4.70 $1.38
Warrant Expiration Date July 10, 2016 July 10, 2019 December 21, 2015 May 25, 2017 October 2, 2017
Warrant Strike Price ($) $10.00 $18.33 $42.31 $40.00 $40.00
Time Till Expiration (years) 2.71 5.71 2.15 3.58 3.94
Total Stock Price Increase Required for Break Even ($) $0.50 $1.14 $10.67 $8.21 $21.71
Total Stock Price Increase Required for Break Even (%) 1.40% 3.20% 29.98% 22.50% 110.37%
Stock CAGR Required for Break-even (%) 0.52% 0.55% 12.95% 5.83% 20.79%

From the table above, GM stock needs to appreciate very little over the next few years for the GM Series A and Series B warrants to break even at expiration. The underlying stocks need to perform well over the next few years for the GM Series C warrants, KMI warrants, and Dynegy warrants to break even.

These warrants provide leverage to investors who want to get exposure to these non-financial companies. All three of these companies are trading at low valuations due to company-specific negatives. Now may be a good time to start or build a position in the companies using these warrants.

Disclosure: I am long GM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long GM Series B warrants.