As a result of dry bulk shipper Seanergy’s (NASDAQ:SHIP) announcement of the pricing of their public offering, Seanergy’s shares were cut in half on Thursday, May 9th. The shares opened at $1.84 after closing at $3.65 a day earlier. In the offering, Seanergy announced that 4,200,000 units would be sold at a price of $3.40 each. Each unit includes one share or one pre-funded warrant in place of the share, one Class B warrant [SHIPZ] and one Class C warrant. The Class B warrant has a term of three years with an initial exercise price of $3.74 and the Class C warrant has a term of six months and also with an exercise price of $3.74.
What may not have been immediately apparent for current shareholders is that the Class B and Class C warrants aren’t as benign as presented in the company's press release, which only stated the expiration dates and and initial exercise price of the warrants. The warrant terms are actually worse for existing shareholders. On the other hand, at share prices above $1.00, Seanergy’s offering is virtually risk free for the buyers of the units through just the shares and the Class C warrants, with the Class B warrant offering an additional benefit. Unit holders also have the ability to improve their own return from the offering in a relatively short period of time by selling shares and driving down the share price to make a Class C warrant cashless conversion more favorable for themselves.
Public Offering Benefit to Unit Buyers
The one common share received from the $3.40 per unit offering price is easy enough to understand. It can be sold into the market at market price. Additionally at share prices over $1.00, the Class C warrant perfectly complements the common share to virtually ensure that the unit holder will be made better than whole, as Class C terms allow for a cashless exercise. Starting on June 14th and continuing until expiration five months later, the Class C cashless exercise allows the holder to get a number of shares per warrant according to the formula below, assuming the market price is $1.00 or higher:
($3.74 – market price)/market price
With $3.74 being the Class C warrant strike price. At this point, the number of shares received in the cashless exercise from each Class C warrant can be sold into the market for a total dollar value of:
$3.74 – market price
Then adding in the market price received for the original share from the unit, if sold, means the buyer of the unit who sells the original share plus the shares from the cashless exercise will receive:
$3.74 – market price + market price … or $3.74 per unit
The benefit from the share and the Class C warrant exceeds the $3.40 paid for the whole unit. If Seanergy's market price is less than $1.00, then $1.00 is substituted for the market price which would give the unit holder somewhat less of a return, but the share price would have to drop to around $0.68 before unit holders start to lose money. This $1 limit becomes important for unit holders’ motivation to convert.
In addition to the unit holder being made more than whole at share prices above $1.00, the unit holder also has the Class B warrant which, after seven months and if the share price is below $2.83, will have the strike adjusted downward to the higher of $1.00 or 120% of the market price to benefit the warrant holder.
What will happen from here?
The potential dilution from this offering is substantial. Seanergy initially had about 3M shares, but with 4.2M new shares being added directly, another potential 11.5M from the Class C warrants and a potential 4.2M shares from the Class B warrants being exercised, plus underwriter shares, Seanergy’s share count could be well over 20M shares, up by a factor of seven or so.
The unit holders have an incentive to sell given the risk of the share price dropping below $1.00 where they start benefiting less. That will likely make a drop below $1.00 self-fulfilling. If the common shares were safely above $1, the unit holders could minimize their risk by waiting until June 14th when the Class C warrants can be exercised on a cashless basis, and then selling the original shares and Class C shares together to get close to $3.74 per unit. Likely, however, unit holders can see the risk of a share price decline and may want to sell as soon as possible, knowing that the share price in a month will likely be lower as the other unit holders’ shares hit the market. Other unit holders selling into the market and driving down the price will actually make the Class C cashless conversion more valuable as the share price approaches $1.00.
Alternatively, if Seanergy's shares are still above $1.00 on June 14th, the day when the cashless exercise option becomes available, unit holders will also see that converting on a cashless basis and driving down the shares will maximize their own return per the cashless exercise formula. Given the large number of potential shares which can be derived from the cashless exercises and the initial incentive to convert near $1.00, it seems very likely that the shares will drop at least down to $1.00, likely lower as any unit holders who wait to convert would be at a higher risk of not receiving as much from the conversion if the share price drops below $1.00. With the potential dilution and the potential drive of unit holders to collect a return, Seanergy’s shares falling below $1 seems much more likely than not.
Seanergy’s public offering carries potential for much higher dilution than may have been immediately apparent and shareholders should be wary. For those who believe in Seanergy’s long-term potential, it may be better to revisit the shares at some point after June 14th when the Class C cashless conversion option becomes available and at a time where the dust may already have settled from the offering. At the current time, there’s too much downside risk with the offering to hope that a turn around in the dry bulk business will instead drive the share price higher.
Disclosure: I am/we are short SHIP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.