Was Convoy Involved in Illegal Market Manipulation After Issuing 80 Million Underpriced Warrants?

To the Securities and Futures Commission and the Media:

Earlier this year, on Feb 25, Convoy announced the issuance of 80,000,000 new warrants. In less than two weeks, for no apparent reason, Convoy’s stock price more than doubled from $1.30 to $2.70. It’s too difficult to do an exact calculation, but I estimate that the value of those warrants increased by a factor of more than 100, giving the owners a potential quick profit of more than $100,000,000. The public deserves to know the truth: Who did Convoy sell the warrants to and why? Did those people sell the warrants after Convoy’s stock price doubled? Who was buying the largest volume of Convoy’s stock and driving the price to record highs? Why were these people buying so much of Convoy’s stock? Was there anything unethical or illegal happening? How was Convoy involved?

At the request of the Hong Kong Stock Exchange, Convoy issued an announcement denying any involvement, but should we trust a company who has historically earned almost all of its revenue by ripping off the public (selling ILAS)? I encourage SFC and the media to investigate further to independently verify what really happened. It would be foolish to take Convoy’s word at face value.

What follows is a more detailed summary of the events that took place, along with links to the relevant documentation. You can find all of it and more on theAnnouncements page of the Investor Relations section of Convoy’s website.

On February 25, Convoy announced that it was creating and selling 80,000,000 warrants to “not less than six” undisclosed “Independent Third Parties”. Half the warrants can be exercised between Jan 1, 2015 and Mar 10, 2018, and the other half can be exercised between Jan 1, 2016 and Mar 10, 2018. Their exercise price is $1.41 (the closing price of Convoy’s stock on Feb 25). Although the warrants can’t be exercised before Jan 1, 2015 (and 2016), it seems they can be sold before then, and as far as I can tell, the sale doesn’t have to be publicly disclosed unless the warrants are sold to individuals classified as “connected persons”. The buyers paid $0.01 for each warrant (although it seems the warrants should have been sold for far more than that, as I will explain below). In total, the buyers paid $800,000 for all 80,000,000 warrants. However, Convoy estimated it would only earn approximately $600,000 after paying transaction fees. This is a minuscule amount of money for Convoy. When they last reported, Convoy had $161 million in cash and $0 debt. They earned a profit of $53 million in 2011. Convoy claimed the reason for selling the warrants was to raise money to utilize as “general working capital”. I am skeptical. There was no urgent need to raise such a small amount of money. Plus, there was a much better way to raise the same amount of money, a way that wouldn’t have been so harmful to the interests of public shareholders—They could have issued a small number of shares, not a massive amount of warrants.

Convoy only has a float of 94,410,000. When the 80,000,000 warrants are exercised and flipped onto the market, it will massively dilute public shareholders. Convoy could easily have raised $600,000 by issuing 160 times fewer shares than warrants. 500,000 new shares sold at $1.41 would have raised $705,000 before transaction fees. (Note that they didn’t hesitate to issue 26,000,000 new shares on March 26.) So why didn’t Convoy issue 500,000 shares on Feb 25, rather than selling 80,000,000 warrants for $0.01 each (an artificially low price which short-changed shareholders)? Convoy’s board of directors claims that the warrant issuance was “in the interests of the Company and the Shareholders as a whole.” I disagree. I think the interests of the warrant purchasers were prioritized above everyone else’s interests.

I’ll illustrate by first examining two alternative scenarios.

(1) Let’s suppose that the 80,000,000 warrants are exercised on Jan 1, 2015, and on that day, Convoy’s stock price is $3.00. The warrant owners have a right to buy 80,000,000 shares at $1.41, and they can immediately sell them for $3.00, earning a profit of $1.59 on each share. The warrant owners will earn a total profit of $127,200,000. Convoy and its shareholders will only collect $112,800,000 (from the $1.41 per share paid by the warrant purchaser).

(2) Now let’s suppose that on Feb 25 this year, instead of issuing 80,000,000 warrants, Convoy chose to issue 500,000 new shares. Now let’s suppose that on Jan 1, 2015, instead of 80,000,000 warrants being exercised, Convoy issues 80,000,000 new shares at $3.00 each. Convoy and its thousands of public shareholders will take in $240,000,000, getting to keep all of the $127,200,000 that would otherwise have gone into the bank accounts of the “not less than six” “third parties”, as described in scenario (1) above.

In both scenarios, shareholders get diluted, but in the second scenario, shareholders are rewarded with an additional $127,200,000. Clearly, the second option would be better for shareholders, which demonstrates that the warrant issuance wasn’t in shareholders’ best interests.

To prove that the warrants were underpriced, I’ll draw your attention to the first time that Convoy announced they were issuing warrants, on Feb 16, 2011. Convoy sold 50,000,000 warrants on much less agreeable terms, yet they charged double the price for them ($0.02). The 2011 warrants expired in 1 year, but the 2013 warrants will expire in 5 years. The 2011 warrants were broken into 3 sets with exercise prices of $1.60, $1.80, and $2.00. The 2013 warrants all had a much lower exercise price of $1.41. The 2011 warrants had a clause which capped the potential profits that could be earned by the warrant purchasers, but the 2013 had no such clause. The 2011 cap worked like this: If the stock price of Convoy averaged above $2.10 for 20 consecutive trading days, then the warrants would automatically be exercised. But with the 2013 warrants, if Convoy’s stock price goes to $100, it doesn’t matter. The warrant owners never get called away. They can exercise the warrants after the stock price goes to the moon. Everything considered, the 2013 warrants sound like a MUCH better deal. I suspect this is why Convoy had no problem selling the maximum amount allowed by their General Mandate (80,000,000). To quote Convoy’s Board: “the Board considers that the terms of the Warrant Placing are on normal commercial terms and are fair and reasonable and in the interests of the Company and the Shareholders as a whole.” If that’s true, why did Convoy sell the 2013 warrants for half the price of the 2011 warrants? Was it really in the best interests of shareholders? Or was it in the best interests of the warrant purchasers?

I would also like to draw everyone’s attention to the fact that Convoy’s stock price has spiked twice since it began trading after its IPO. The first time was immediately after the 2011 warrants were issued. The second time was after the 2013 warrants were issued. I suspect Convoy learned something from their first experience and couldn’t resist juicing up the winnings for their second one.

The 2011 warrants were never exercised and expired worthless, but I wonder, did the original purchasers of the 2011 warrants flip them after the stock spiked? And did the 2013 purchasers flip them after the most recent spike?

Let’s take a look at the events around the recent spike in Convoy’s stock price.

It was announced on Feb 22 that Mr. Chan Chi Keung, Convoy’s founder, sold a massive stake in the company (19.69%). Three days later, on Feb 25, Convoy announced that 80,000,000 warrants were being issued. From a low of $1.30 on Feb 25, Convoy’s stock price more than doubled to $2.70 by March 8. Then, on March 13, it was announced that Mr. Lee Kwok Yin, Denthur (who had joined Convoy early in 1998) had also sold a huge stake in the company (20.35%).

There was no explanation for why these two men sold their stakes (or who they sold their stake to), but perhaps they share my opinion that Convoy is headed towards oblivion as soon as regulators crack down on ILAS. Or perhaps the reason for their selling was related to the issuance of 80,000,000 warrants on Feb 25. I can only speculate.

The sudden and unexpected rise in Convoy’s stock price raised some red flags at the Hong Kong Stock Exchange. At the request of the Exchange, Convoy’s Board of Directors released an announcement on March 4, in which they claimed no knowledge of why their stock was surging. I find that highly unlikely.

As I mentioned above, as far as I can tell, the warrants can be sold at any time. Calculating their exact value would be similar to calculating the value of a stock option. This is an extremely complicated calculation which I don’t know how to do, but I will explain how I estimate their value.

The warrants can be exercised for $1.41. On March 8, Convoy’s stock touched $2.70, so at that moment, the warrants had an intrinsic value of $1.29 ($2.70 – $1.41). But all warrants also have a time value in addition to their intrinsic value. The 80,000,000 warrants don’t expire for 5 years and Convoy’s stock price is extremely volatile. Both facts make the warrants worth a lot more money than just their intrinsic value. So, on March 8, I estimate that the warrants were worth at least $1.29 each and perhaps as much as $2.00 or more. (Despite being purchased for just $0.01!)

In total, 80,000,000 warrants were purchased for $800,000. Two weeks later, after the stock spiked, I estimate those same warrants had a total market value well over $100,000,000, or maybe even $150,000,000. Were the warrant owners just lucky? Or did they have a role in manufacturing the rise in Convoy’s stock price? How about Mr. Lee Kwok Yin, Denthur who sold his stake in Convoy at the top of the bubble?

It’s my opinion that the warrants will never be exercised because Convoy’s stock price will head towards zero after ILAS sales collapse. If the warrant owners agree with me, then they will surely aim to dump those warrants long before the crash. Perhaps they have already sold. If not, they will do it soon, while Convoy’s stock is still selling at an artificially high price. Whoever is left holding the bag will be financially obliterated.

I learned a few days ago that Convoy’s stock cannot be short sold. SFC regulations require a company to have a market cap of $10 billion before its stock is eligible for short selling (Convoy’s market cap is $0.8 billion). Consequently, it’s very easy for the price of a small-cap stock like Convoy to be manipulated upwards (by an orchestrated burst of buying), but it’s impossible for it to be manipulated downwards (by an orchestrated burst of short-selling). This means that anytime someone (such as the owners of 80,000,000 warrants) is determined to artificially inflate the stock price of a small cap stock, short-sellers are unable to apply opposing pressure, guaranteeing the creation of a bubble which will burst and inflict immense damage to whomever the manipulators unload their stock (or warrants) on at the height of the bubble. I don’t know if there exists a good reason for this double standard in the rules, but I urge SFC to consider revising them. I believe that the moment Convoy’s stock ever becomes eligible for short selling, it will get annihilated. It is trading at a level it never should have reached, in part because fund managers who agree with me are prevented from expressing their opinion by short selling.

I appreciate that everyone has taken the time and effort to read this message. I hope you will give the issues I’ve raised the attention they deserve. I’ve attached some charts to illustrate my arguments above, and I will be cc-ing this message to other Hong Kong regulators and several fund managers.

Lindell Lucy

On Two Occasions Convoy's Stock Price Spikes After Warrants Are Issued


Convoy's Stock Price Doubles After Warrants Are Issued on Feb 25


2011 Warrants vs. 2013 Warrants

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