When a company goes public, it’s usually cause for celebration for investors. But when companies return to the capital markets to do secondary offerings of stock, the shares often get a lot less fanfare — and the results for existing shareholders can be much less profitable.
Recently, a number of companies have announced plans to make secondary offerings, and investors have responded to the news by sending their stock prices downward. But if secondary offerings are such a bad thing, why do companies do them? Let’s take a closer look at what motivates companies to make secondary stock offerings and whether they’re always a signal to sell.
Why all secondary offerings aren’t the same
Companies do secondary offerings for two primary reasons. Sometimes, the company needs to raise more capital in order to finance operations, pay down debt, make an acquisition, or spend on other needs. With this type of offering, a company actually issues brand new shares, increasing its existing share count. For instance, Achillion Pharmaceuticals, Inc. (NASDAQ:ACHN) announced last week that it would raise $125 million in a stock offering, saying it plans to use the proceeds for research and development on its pipeline or for other purposes. Another example is master limited partnership Golar LNG Partners LP (NASDAQ:GMLP), which has done several offerings in recent months in order to finance asset purchases.
When a secondary offering involves the issuance of new shares, the main concern for existing shareholders is dilution. With an increase in shares outstanding, the stock position you own represents less of the overall company, and you’ll get a proportionately smaller share of the company’s profits going forward. The trade-off, though, is that the company gets to keep the cash raised from the offering, which increases its overall value.
Many secondary offerings occur when the business badly needs capital, and that’s most likely to happen when shares have been beaten down. Obviously, selling new stock when share prices are depressed is the worst possible timing and explains why reactions are so often negative. By contrast, closed-end fund Central Fund of Canada Limited (USA) (NYSEMKT:CEF) often uses secondary offerings as ways to capitalize on premiums to its net asset value, resulting in accretion to NAV rather than dilution.
Getting out while the getting’s good
In other cases, though, secondary offerings happen because major shareholders want a chance to sell out. Recently, there’s been a spate of this type of secondary offering. Michael Kors Holdings Ltd (NYSE:KORS) fell nearly 10% in two days last week after saying it would do a 25-million-share offering worth roughly $1.5 billion, with founder Michael Kors selling 3 million shares he owns personally.
Often, private-equity investors and other early-stage financiers are involved in the decision to do a secondary offering. Generac Holdings Inc. (NYSE:GNRC), which has gained prominence recently because of its production of generators in the wake of Hurricane Sandy, will offer 10 million shares owned by CCMP Capital.