Heavy Dilution From Cashless Warrants Is Forcing Naked Stock Down

Stocks to sell

Naked Brand Group (NASDAQ:NAKD) is now facing the consequences of its disastrously dilutive capital raise last month. I wrote about this situation on March 11 and how NAKD stock would fall from the massive cashless warrants. As a result, the hedge funds who underwrote the capital raise have been dumping their shares and cashless exercise warrants. I will show you why this made sense for them but only hurt NAKD stock owners.

a man and woman wear plain white underclothes from Naked Brand (NAKD)

Source: Shutterstock

At the time the capital raise related to a $100 million capital raise on Feb. 25 at 93 cents per share in return for 107.53 million shares. But they included some out-of-the-ordinary cashless warrant provisions for potentially even more warrants. I showed how the number of warrants could be extremely high.

However, since then the company announced on March 11 that it had raised the number of shares sold to $117.65 million at 93 cents. This means the capital raise brought in $94.89 million after expenses. But it also implies that there were a larger number of cashless warrants.

How Hedge Funds Made Money on Naked Stock

The best way to see this is to actually work out the math from the standpoint of the hedge funds that paid $93 cents per share. Even though the stock opened around $70 cents today, they can still make money.

The reason is they received a large number of cashless exercise warrants. You should really read my previous article to see how these work. But essentially cashless exercise warrants allow hedge funds to reduce their overall cost.

Normally a cashless exercise of warrants implies that the company will take any cash it receives and buy back NAKD stock at 70 cents. So, using this morning’s price, the number of cashless warrants for 117.647049 shares is calculated as follows:

(117.647049 x $0.93) / $0.70 = $109.411175 million / $.70 = 156.3 million warrants

However, under the terms of the warrant agreement, the company agreed to use the bid price on Feb. 23, or $1.01. Therefore, the number of warrants =

$109.411175 / $1.01 = 108.328471 million warrants

Therefore, even though the hedge funds as a group paid $109.411 million at 93 cents per share, they actually received 225.9755 million shares:

117.647049 m shares + 108.328471 m shares (for cashless exercise warrents) = 225.9755 million shares

As a result, the all-in cost per share was just 48 cents per share:

$109.411175 million cost / 225.9755 million shares = $0.48417 per share

As a result, the net profit, even at 70 cents per share today is 21.58 cents per share, or $48.772 million:

$0.70 – $.48417 = $0.215827 per share x 225.9755 million shares = $48.77168 million

This represents a very healthy 44.58% ROI (i.e. $48.77 million / $109.411 million outlay) for the hedge funds.  You can imagine, the hedge funds could arbitrage sell the 225 million shares they expect to receive once the deal has closed. That is why NAKD stock fell from $1.01 on Feb. 23 to around 70 cents per share.

What To Do With NAKD Stock

Naked Brand got its cash, but in the process, as you can see above, they destroyed the huge potential upside in NAKD stock. And you can expect that the selling will continue since this arbitrage is still profitable as long as the stock is above 48 cents per share.

In other words, expect to see NAKD stock fall to at least 48 cents per share over the next several weeks. It will also likely go below that just because stocks normally overshoot target prices.  In addition, the company has a number of convertible notes that have similar cashless exercise provisions.

Once Naked Brand decides it has enough cash and stops these sorts of highly dilutive deals, the stock might stabilize. But until then, I would not touch the stock.

In addition, the market needs to see how much cash the company presently has in the bank as well as the number of shares it has outstanding. This likely won’t be available until its first quarter earnings statement is released. That probably won’t happen before May, so avoid NAKD stock until then.

On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article.

Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.

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