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Deutsche Bank lays seeds for future with warrants in Japan

by Finbarr Flynn and Shingo Kawamoto

Bloomberg

Deutsche Bank AG is helping smaller Japanese companies less able to access the bond market raise money using warrants, as it searches for investment banking clients to generate future business.

The German lender was the lead sales arranger in 2013 of warrants, securities that give a holder the right to buy shares of a company at a fixed exercise price, its own data show. The market for contracts sold to investment banks expanded fivefold to ¥107 billion ($1 billion) last year, according to Bank of America Corp. data. This year, Deutsche Bank is trailing Bank of America in the arranging stakes, that data show.

Prime Minister Shinzo Abe’s unprecedented fiscal and monetary stimulus triggered a 137 percent surge in the Tokyo Stock Exchange’s Mothers market for high-growth stocks last year, making it more attractive for smaller companies to sell the securities, which provide almost no funds for the issuers unless they’re exercised. Biotech companies including RaQualia Pharma Inc. and ReproCell Inc. have used the contracts in 2014 as the Mothers index pares losses generated the first four months of the year.

“Some of these companies may certainly grow and be very significant, and we’re sowing the seeds for the long term,” said Simon Roue, the head of corporate finance at Deutsche Securities Inc. in Japan. “That’s the model for banking.”

Under the warrant programs used by Deutsche Bank and Bank of America’s Merrill Lynch Japan Securities Co., an issuer’s approval is needed before holders, the investment banks, can exercise them to buy shares. Warrants are most appealing to companies when stocks rise because they’re able to sell fewer shares at a higher price to raise funds.

Along with RaQualia Pharma, a developer of compounds for new drugs, and ReproCell, a stem-cell medical research firm, KLab Inc., the maker of the most popular music game for Apple Inc.’s iPhones in Japan, raised funds via warrants this year.

“The main thing is that the issuer can draw on funds flexibly,” said Kenji Harada, a director at Merrill Lynch’s investment banking division in Tokyo. While it takes about two months for companies to prepare for a public share offering, warrants can be arranged in about two or three weeks, he said.

The Topix Small Index of 1,310 companies, which tracks small-cap corporates, has risen 12 percent since May, bringing gains for the year to 5.2 percent. That’s better than the broader Topix index, which is down 1 percent.

KLab, a member of the Topix Small Index, raised about ¥1.1 billion last month when Deutsche Bank exercised 1 million warrants to buy the same amount of shares at ¥1,100. It has raised ¥2.7 billion via warrants exercised by Deutsche Bank since November. KLab’s stock has climbed 132 percent this year to ¥1,863 as of Thursday.

“It was possible for us to control the timing and size on the exercise of the warrants,” Kazuyuki Takata, an executive vice president at KLab, said by email on Wednesday, asked about warrants’ key advantages. “Compared with a public share offering, dilution of the share price doesn’t occur all at once, so it’s possible to reduce the relative impact.”

Many companies using warrants are doing so to take advantage of a “strong market price,” according to Deutsche Bank’s Roue. The lender doesn’t seek to hold onto the acquired shares, and tries to find institutional investors who want to hold the stock for a reasonable period of time, or sell in an orderly fashion into the market, he said.

“Doing a trade should be successful for both the company and ourselves but we see these warrants as a way of showing the company we have their interests at heart,” Roue said.

Deutsche Bank has learned from past experience that working with clients from an early stage can generate future profits.

The German lender helped finance SoftBank Corp.’s ¥1.7 trillion purchase of Vodafone Group Plc’s Japanese unit in 2006 and was appointed after the deal to help refinance that debt. SoftBank is Japan’s most profitable wireless carrier.

It also advised the carrier on its $21.6 billion purchase of Sprint Corp. in the U.S. last year, and was the only non- Japanese bank selected in December 2012 as an arranger of the debt backing the deal.

The Frankfurt-based lender and Bank of America accounted for about 63 percent of warrant deals involving investment banks in 2013, while Nomura Holdings Inc., Macquarie Group Ltd., UBS AG and SMBC Nikko Securities Inc. also inked transactions, according to Bank of America data.

Bank of America’s Merrill Lynch Japan Securities leads the market so far this year with a 30 percent share of about ¥45 billion of deals, versus Deutsche Bank’s 9.8 percent.

RaQualia Pharma, which is forecasting a full-year operating loss of ¥1.68 billion this year, sold ¥1.37 billion of warrants to Merrill Lynch Japan Securities in July. The company, whose stock has fallen 18 percent this year to ¥559 as of today, issued the warrants on July 22 at an initial exercise price of ¥621 and a minimum of ¥435.

RaQualia Pharma develops compounds for new drugs and licenses them to partners who seek to bring them to the market, according to its website.

Merrill Lynch Japan Securities can exercise the pharmaceutical company’s warrants at 90 percent of the share price with the issuer’s approval, as long as it stays above the lower price. The drug company decided to issue new warrants this year because its stock price fell below a previous price floor.

Bank of America’s Japan unit has arranged 12 deals for issuers since November 2012, more than any other investment bank, and exercised at least part of the warrants on each deal, according to Harada.

“It’s difficult for venture companies like ourselves to borrow funds basically because of a lack of collateral,” said Kiichiro Kawada, an executive at RaQualia Pharma. “While warrants result in dilution it’s difficult to generate value during the development stage so by using the funds effectively we will seek to get licenses as quickly as possible to increase sales.”