SINOTOP – Significant Market Mispricing Between Rights Issue! 100% Jump In 4 Days. Opportunity or Trap?!
Jun 29th, 2010 Posted in Intelligent Investing
Saw SINOTOP and SINOTOP-OR (the rights share) trading as most active stocks today and wonder what they are. Did a search and realized it is the previous John Master (now a empty shell company). Be Top, a textile company in China is taking up the shell company to get listed in Bursa [geek call this ‘reversed merger’]. Then they try to raise $$$ by issuing 10 rights shares for every 1 share. Exactly like stock options, holder of the rights shares can buy 1 new share at ‘only’ RM0.20.
What is so confusing and interesting is this -
SINOTOP is actually selling for RM0.65 while the right is sold at RM0.12. It means, if you want to own SINOTOP shares, you can either buy directly at the market now at RM0.65, or you can buy the right share (SINOTOP-OR) at RM0.12 and exercise it to get new shares at RM0.20 with a total cost of only RM0.32!!! A discrepancy of RM0.65 to RM0.32, 100% differences!!!
What went wrong? I don’t know yet. But at least what we know is, if you are a holder of SINOTOP shares, the only sane thing to do is to sell every SINOTOP you have and bought an equivalent amount of SINOTOP-OR and fully exercise them. By doing that you will reduce your cost by 50% immediately!
Again, I know nothing about this business. And I don’t like textile company either (Berkshire Hathaway used to be a textile company that failed, a Warren Buffett investment ‘mistake’).
Calculating the pricing or market share price and the right price is not simple mathematics (at least to me). It reminds me of the time where I needed to calculate the amount of electrons in a silicon and the dy/dx… I hate those and doing this right issue calculation now make my head spin again like old time. But still, let me try my best on it and we learn together.
Every time there is a right issue, you need to make 2 formulas (actually 3). The 2 formulas allows you to link the market price BEFORE the right issue with the market price AFTER the right issue. Because after a right issue, the market price will immediately drop. You can only compare the BEFORE and AFTER price if you can either convert the AFTER price to BEFORE equivalent or convert the BEFORE price to AFTER equivalent.
It is like changing from kilograms to pound or kilometers to miles … you can only compare the market price either using the AFTER metrics or BEFORE metrics. Say today the AFTER rights price is RM0.65, what is the equivalent price BEFORE the rights issue? And 1 month ago, the BEFORE rights price is RM0.85, what is the equivalent AFTER rights price today?
The 3rd formula is actually the SINOTOP-OR (the right share) price. This is the most straightforward formula. We will later use this formula to get the other 2 formulas.
Rights Price = Market Price after rights issue – Rights Issue Price
(note: rights price is the rights market price, rights issue price is the strike price, the exercise price)
SINOTOP-OR = SINOTOP AFTER – RM0.20
The right shares, like call options and stock options, allow you to buy the underlying share at a fixed amount, that’s RM0.20 (geeks call this ‘strike price’). So technically, the right price will simply be the market price minus the strike price. Because you either buy directly at market price, or you buy the rights shares first (like paying upfront deposit) and pay the remaining later when you exercise it. No matter which way you do, you are getting the same thing in the end, the SINOTOP shares, the same apples.
If SINOTOP-OR is trading below SINOTOP AFTER – 0.20, we say it is trading at a discount, because by buying this ‘apple’ via the rights issue, you get the apple cheaper by buying it directly in the market.
On the other hand, if SINOTOP is trading above SINOTOP AFTER – 0.20, we say it is trading at a premium, because this apple is now more expensive than the market price.
“Usually”, we seldom see behavior like SINOTOP where there is a significant difference between the rights price and the market price (a big discount in this case). Usually they are almost the same, either slight discount or slight premium.
Uninformed investor who sell SINOTOP-OR is understandable because rights shares have short life, usually a week (geek call it the ‘expiry date’). After this date, your rights is worthless and you can no longer sell it in the market, the only thing you can do is exercise it at the strike price and get new shares. So the only reason you want to hold rights shares is to exercise it. To exercise it, you need to take fresh money out from your wallet. So if an existing shareholders who doesn’t plan to exercise the rights or have no money to exercise the rights, he will have to sell the rights shares before it expires to get some money. Or else, he will get nothing after they expire!
And since SINOTOP is issuing a massive 10 rights share for 1 existing shares, existing investors suddenly have 10 rights share, they either have to come up with the 10 rights share money or they will have no choice but to dump it at the open market. And they can only sell within a week! Lots of supply in a short period of time, but no demand.
That’s why next time if you encounter such scenario where one of your stock holdings is issuing massive rights and you still want to own this stock, sell some of it before you get the rights to raise your cash and then buy back back again through the rights. Do not plan to sell the rights because many people are trying to do the same and you won’t get good price for your rights!
[Many companies issue rights but usually they don’t issue 10 right for 1. They normally issue say 1 right for 4, or 1 right for 8 so that is acceptable and it won’t create too much sell supply to the rights shares, like BSTEAD and AXIATA previously]
What went wrong with SINOTOP is still unknown, and why got sohai buying up at the market is also unknown! Because I have shown you, it didn’t make sense to buy at market price and sell the rights! Instead you should do the other way, sell at market price and buy the rights!
If you do not have the 2 formulas in hand, you can’t compare the differences BEFORE and AFTER and so you won’t be able to know how much the market price of SINOTOP has shot up since the rights issue. Let’s derived the 2 formulas.
Market Price before rights issue = Market Price after rights issue + ( Ratio x Rights Price )
The Ratio is 10:1 so is 10. The Rights Price has been derived earlier. Replacing the ratio and rights price, we get
SINOTOP BEFORE = SINOTOP AFTER + 10 ( SINOTOP AFTER – RM0.20 )
SINOTOP BEFORE = SINOTOP AFTER + 10 SINOTOP AFTER – RM2.00
SINOTOP BEFORE = 11 SINOTOP AFTER – RM2.00 … formula (1) to convert the AFTER price to BEFORE price equivalent for comparison.
By reversing the formula, we get
SINOTOP AFTER = ( SINOTOP BEFORE + RM2.00 ) / 11 … formula (2) to convert the BEFORE price to AFTER price equivalent for comparison.
Actually they are the same formula, depending on whether you want to convert km to miles or convert miles to km.
Since the right will expire very soon (in a week) and cease to exist, so this 2 formulas are more important than the rights formula earlier. The rights will be RM0 after it expires.
To make sense of SINOTOP, just the day before the right issue, it was traded around RM1.60. Just a day after the right issue, it was around RM0.40. To link this 2 numbers together, you can either convert the BEFORE price to AFTER or the AFTER price to before. You can use either formula.
If it is RM0.40 AFTER, what it is the equivalent BEFORE?
SINOTOP BEFORE = 11 SINOTOP AFTER – RM2.00
= 11 x RM0.40 – RM2
That means SINOTOP has ‘technically’ shot up from RM1.60 to $2.40 in terms of BEFORE price, a 50% raise in high volume in 1 day!
4 days later, the AFTER price shoot up to RM0.65. Converting it to BEFORE price, it would be RM5.15!!! 220% gain from RM1.60 in 4 days after the rights issue. No wonder BURSA is issuing them questioning letter. But the directors responded in the same way, “we are not aware of anything.”
This is more mysterious when you take into consideration that just 1 month earlier, the BEFORE price is only RM0.85. An increase from RM0.85 to RM5.15 in 1 month is 500%!
And even MORE mysterious is that there are rights shares pending that sell for only RM0.12 with an issue price of RM0.20! Again who is the sohai who buy SINOTOP at the market but refuse to buy the SINOTOP-OR and exercise it to get SINOTOP shares for 50% discount to market price?
It is possible that I did the wrong calculation above, if you spot any mistakes, please let me know as I am eager to find out too.
To make more sense, let’s get back to basic formula that normal investor can understand easier.
A BEFORE investor who buy at BEFORE price will now be holding the same stock at AFTER price + 10 rights shares. This is our basic formula.
Market Price before rights issue = Market Price after rights issue + ( Ratio x Rights Price )
SINOTOP BEFORE = SINOTOP AFTER + 10 Rights Price
The investor might be thinking that since BEFORE the rights, it is at RM1.60, and AFTER the right, it is RM0.65, so they estimate that the “right” rights price should be
Rights Price = ( SINOTOP BEFORE – SINOTOP AFTER ) /10
That way they get the rights price at (RM1.60 – RM0.65)/10 = RM0.095. If they are able to sell their rights shares above RM0.095, they are still much richer than before by holding the “inflated” RM0.65 SINOTOP shares.
But I don’t think they should be too happy because the pricing of SINOTOP after right issue is far way off from logic. As I have shown you, RM0.65 means an equivalent of RM5.15 for the BEFORE price! A jump of 220% in 4 days! Unless you have unloaded everything (both the shares and the rights), you are “richer” because you are relying on the inflated SINOTOP share price.
Problem #1 – SINOTOP price is highly inflated. It jumped 220% in 4 days.
Problem #2 – 50% mispricing between SINOTOP and SINOTOP-OR. Buying SINOTOP-OR to get SINOTOP is 50% cheaper than buying SINOTOP at market. But they are the same apple!
Let’s turn the mirror and use formula (2) to compare in AFTER price.
SINOTOP AFTER= [ SINOTOP BEFORE + RM2.00 ] / 11 … formula (2)
Before the rights issue, SINOTOP is trading at around RM1.60. So technically, SINOTOP AFTER should be worth RM0.33 after the right issue if it is equivalent to RM1.60. But it is RM0.65 now! Almost 100% jump in 4 days.
The pricing of the right is about “right” right now [sorry for using 3 right words in 1 sentence].
Because if you get the right at RM0.12, and exercise to get the stock at RM0.20, your total cost would be RM0.32, almost equivalent to the RM1.60 price before the right issue. So now we know getting the shares through the rights “right” now is almost the same as buying it at RM1.60 before the right issue.
And since one month ago it is traded at only around RM0.85, the equivalent AFTER price would be only (RM0.85 + RM2.00) / 11 = RM0.25!!!
I also think formula (2) is a better metric to use than formula (1) because it can explain in this way – If you have bought the SINOTOP shares before the right issue and you exercise all your rights, what is your average cost for your SINOTOP shares? If you bought it at RM1.60, and exercise all shares at RM2.00, you got 11 shares in return. So averaged cost is RM0.33, which is formula (2). Selling it later at RM0.65 gives you a profit of almost 100% based on your cost.
Formula (2) is also the formula to adjust historical pricing in stocks charts before the rights issue.
So if you are a SINOTOP shareholders or plan to buy SINOTOP, it is your homework to know if SINOTOP is really worth RM1.60 BEFORE the rights issue (which is equivalent to your cost of RM0.32 right now if you buy through rights). If it is not worth RM0.32 right now, it is definitely not worth RM0.65.
The market price now is inflated to RM0.65, if you are buying the rights to get the shares, do you think the stock price will still be RM0.65 after you get the shares (around 1 month)? If yes, you will make a 100% profit! You will be profitable as long as it is above RM0.32. But really got naked woman walking on the street? Some nude beach got but is this the rare nude beach?
I got itchy and bought a little bit of SINOTOP-OR before I do any homework (bad role model). I do so to motivate me to work out the numbers (lame excuse) and now I have to admit that I wish I have not bought any. I either have to sell it at a loss tomorrow or work out the real fundamentals numbers of Be Tops before I decide if I want to go ahead and exercise the rights.
Ahhh, pain in the ass. If you know anything about SINOTOP or saw any mistakes I made in the calculation, please write a comment below. Thank you.
p/s Why using formula (1) gives us 220% gain while formula (2) is only 100%? This is because when we compare in BEFORE price, the new rights shares haven’t exist and we need to deduct the cost out from it ($2). So the % gain is based only on initial cost buying the pre-right shares only (without including the new cost to buy the new shares). On the other hand, formula (2) which is more realistic, averaging the gain with all shares and cost. I have to admit, I am confused myself.
If an investor bought RM10,000 of shares before the rights issue at RM1.60, he got 6,250 shares. After the right issue, he will get 62,500 right shares and if he exercised them all at RM0.20, he will need another RM12,500, making his total investment RM22,500 and he will now have a total shares of 68,750. If the stock is selling at RM0.65 today, his whole investment will be worth 68,750 x RM0.65 = RM44,687, which is almost 100% gain. Which is formula (2).
On the other hand, if we use the “unrealistic” formula (1), we need to get back to the time where there is no rights issue. So although the whole investment is worth RM44,687, we need to deduct the investment cost of RM12,500 to it, and get RM32,187. That will be a gain of 220% comparing to the cost of RM10,000. We have assume 0% gain from the shares obtained from the rights shares and attribute all profits to the pre-rights shares. Not an accurate representation.