Warrants Update: N2N warrants offer steep discount

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This article first appeared in Capital, The Edge Malaysia Weekly, on March 27 - April 2, 2017.


AFTER falling to a 52-week low of 62.5 sen per share earlier this year, N2N Connect Bhd’s share price has seen a sharp rebound, rising 24.8% to close at 76.5 sen last Thursday.

The rebound was partially supported by share buybacks. A total of 573,700 shares were purchased from the open market this year. In contrast, the internet technology company’s average daily trading volume has been relatively low — around 51,000 shares in the past two months.

Against this backdrop, N2N Connect has also seen a marked improvement in its net profit for the financial year ended Dec 31, 2016 (FY2016) — up 21.5% year on year to RM11.38 million. This translates into earnings per share of 2.41 sen. The company is being valued at 32.4 times historical earnings.

However, the uptick in N2N Connect’s share price and earnings have not been reflected in the company’s warrants.

Last Thursday, N2N Connect-WA closed at 39 sen apiece. Given the one-for-one conversion ratio and a strike price of 32 sen, the warrants are being valued at a 7.2% discount to the mother share. They have over one year of life left, expiring in April 2018.

It is worth noting that the warrants have a relatively high gearing ratio of 2.26 times.

Moving ahead, a catalyst for re-rating N2N Connect’s stock is the consolidation of Hong Kong-based AFE Solutions Ltd that the company is acquiring for US$20.6 million (equivalent to RM85.28 million).

N2N Connect plans to use AFE Solutions to expand into the Hong Kong market. Like N2N Connect, AFE Solutions is a data and trading solutions provider. The acquisition had been approved by the shareholders of N2N Connect last December, but is pending the satisfaction of several conditions precedent stated on the conditional sales and purchase agreement.

The deal is expected to incur a one-off cost on N2N Connect in the near term as it consolidates and restructures its new subsidiary.

However, it is also a positive sign to see N2N Connect put its balance sheet to work. As at Dec 31, 2016, the company had net cash of RM107 million, which works out to 22.8 sen per share.

It is also interesting to note that N2N Connect pays a relatively small dividend. For FY2016, the company only declared a dividend of one sen per share.

A smaller dividend payout is good for warrant holders as it is less dilutive on the intrinsic value of the warrants. That said, there appears to be ample room for arbitrage in the short term, albeit restricted by the illiquidity of the shares and warrants.