# Secondary offerings and "dilution" **URL:** \ **Category:** Factual Questions\ **Created:** [May 8, 2013, 5:01pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814 "2013-05-08T17:01:01Z")\ **Posts on this page:** 20\ **Page:** 2
**Author:** ![Irishman](https://avatars.discourse-cdn.com/v4/letter/i/b487fb/32.png) [@Irishman](https://boards.straightdope.com/u/Irishman)\ **Post date:** [May 8, 2013, 8:59pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/21 "2013-05-08T20:59:58Z")
Thanks to the post by **dracoi** , I see I am incorrect in understanding. ---
**Author:** ![Malthus](https://avatars.discourse-cdn.com/v4/letter/m/85f322/32.png) [@Malthus](https://boards.straightdope.com/u/Malthus)\ **Post date:** [May 8, 2013, 9:17pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/22 "2013-05-08T21:17:51Z")
> [@Terr](#): > > But you’re not splitting $28 into 6 piles. You’re splitting $28 plus whatever he pays. That’s the point that everyone who says it is “dilutive” seems to miss. Shares aren’t only “about” having a share of the financial value put into the company, like splitting cash in a pot. They also represent a bunch of other rights - notably, control over the company and entitlement to dividends. If you create more shares, you change those rights (ignoring complications about classes of shares etc.) - each current shareholder has less of them, albeit concerning a company that has some more money. It may well be “worth it”, or it may not. ---
**Author:** ![Terr](https://avatars.discourse-cdn.com/v4/letter/t/839c29/32.png) [@Terr](https://boards.straightdope.com/u/Terr)\ **Post date:** [May 8, 2013, 9:31pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/23 "2013-05-08T21:31:46Z")
> [@dracoi](#): > > … > But… the company raised the money to do something with it, right? So it spends $20m. > Market cap might not change - maybe stock is still $11/share, total of $187m. > But the company’s net assets are now only $52m. So each shareholder’s share of assets is only $3.06 per share. > … Usually, for the huge chunks of change that companies get for SPOs, the spending of the $20M buys you something that is added to company assets. Your assumption is that the $20M “spent” is completely wasted. Of course wasting $20M would not be good. That’s not the question. ---
**Author:** ![dracoi](https://avatars.discourse-cdn.com/v4/letter/d/90db22/32.png) [@dracoi](https://boards.straightdope.com/u/dracoi)\ **Post date:** [May 8, 2013, 10:09pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/24 "2013-05-08T22:09:57Z")
> [@Terr](#): > > Usually, for the huge chunks of change that companies get for SPOs, the spending of the $20M buys you something that is added to company assets. Your assumption is that the $20M “spent” is completely wasted. Of course wasting $20M would not be good. That’s not the question. I’m not assuming it’s wasted. It might be spent on R&D, inventory, advertising, facilities, equipment, etc. Some of those add to the books and/or market value as assets and others don’t. But go ahead and plug whatever number you like for remaining assets into my example. Compared to debt financing, the SPO costs the current shareholders no matter what assumptions you use. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [May 8, 2013, 10:23pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/25 "2013-05-08T22:23:29Z")
> [@Terr](#): > > Not really. The better the company does (the less its cost of capital, in this case), the better the shareholder does. I just don’t see anything taken away from the shareholder. If the offering is, for simplicity’s sake, is 100%, then before the SPO the shareholder owns X% of the company. After, the shareholder owns X/2% of the company that is twice the size. How is this not neutral? There’s no objective value of a company. Let’s say Company X has 1 million outstanding shares of stock that currently trade at $10, and they want to raise $1 MM in capital. One way to value the company is to do the simple math of $10 times a million and come up with 10 million. However, say I’m an investor in the company. I think the company is going to perform better than most others do. In line with the rosier profit outlook, I value my share at $15. In other words, I think the company is worth $15 million dollars. So how does the company raise $1 MM? Looking at it simply, they should be able to issue 100,000 new shares and sell them at the current price of $10. But that’s not how it works. A company doesn’t have an objective value. Each investor has their subjective evaluation of the worth of the company. Some will say $20 million, some 15, some 10, some 5, and some even less. So like any other product, the price is a function of supply and demand. When you increase supply without increasing demand, the price is going to go down. So if the company wants to raise money, in most cases they are going to have to price it at less than the current market price. And so what idiot is going to buy the stock at $10 when they know 100,000 shares are going to be sold at $10 - Y soon? Again so going back to the current investor. Not only are you selling ownership in the company for less than I think it is worth, you are driving down the stock price by increasing supply. Neither of these things is going to make me happy. ---
**Author:** ![Terr](https://avatars.discourse-cdn.com/v4/letter/t/839c29/32.png) [@Terr](https://boards.straightdope.com/u/Terr)\ **Post date:** [May 8, 2013, 10:36pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/26 "2013-05-08T22:36:43Z")
> [@treis](#): > > So if the company wants to raise money, in most cases they are going to have to price it at less than the current market price. And so what idiot is going to buy the stock at $10 when they know 100,000 shares are going to be sold at $10 - Y soon? Real world example: DDD. Announced shelf registration yesterday after market close. After market dropped big - 42.5 to below 40. Today in the morning - still dropped big. Since I didn’t believe the offering is dilutive (see my OP) I added to my holdings substantially at exactly 40 just for a short term trade. It ended the day at $44 - $1+ above yesterday’s close. I didn’t really expect it to bounce back and higher than yesterday’s close this quickly, but hey I am not complaining. So - are those who drove the price up idiots? That’s 17M shares traded - four times the average daily volume - by idiots? ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [May 8, 2013, 10:45pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/27 "2013-05-08T22:45:24Z")
> [@Terr](#): > > Real world example: DDD. Announced shelf registration yesterday after market close. After market dropped big - 42.5 to below 40. Today in the morning - still dropped big. Since I didn’t believe the offering is dilutive (see my OP) I added to my holdings substantially at exactly 40 just for a short term trade. > > It ended the day at $44 - $1+ above yesterday’s close. I didn’t really expect it to bounce back and higher than yesterday’s close this quickly, but hey I am not complaining. > > So - are those who drove the price up idiots? That’s 17M shares traded - four times the average daily volume - by idiots? Who knows? The stock had a 10% swing in value in one day. If you note, the immediate reaction to the issuance was a drop of 10% in price. I haven’t the foggiest idea why it came back up. ---
**Author:** ![Terr](https://avatars.discourse-cdn.com/v4/letter/t/839c29/32.png) [@Terr](https://boards.straightdope.com/u/Terr)\ **Post date:** [May 8, 2013, 10:48pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/28 "2013-05-08T22:48:47Z")
> [@treis](#): > > Who knows? The stock had a 10% swing in value in one day. If you note, the immediate reaction to the issuance was a drop of 10% in price. I haven’t the foggiest idea why it came back up. I know why it came up - because as I explained in the OP I don’t think the offering is dilutive at all. I have no idea why it dropped in the first place - and that is what I am asking. I really think the “idiots” (or, shall we say, misinformed people) are the ones that reflexively sell when they hear “shelf registration”. It’s not that I am complaining really - after all, I got mid-five-figure profit due to this Pavlovian behavior in just a few hours, but it is a bit perplexing. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [May 8, 2013, 10:52pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/29 "2013-05-08T22:52:48Z")
> [@Terr](#): > > I know why it came up - because as I explained in the OP I don’t think the offering is dilutive at all. I have no idea why it dropped in the first place - and that is what I am asking. I really think the “idiots” (or, shall we say, misinformed people) are the ones that reflexively sell when they hear “shelf registration”. Are you planning on simply ignoring my explanation while restating your original contention? ---
**Author:** ![Terr](https://avatars.discourse-cdn.com/v4/letter/t/839c29/32.png) [@Terr](https://boards.straightdope.com/u/Terr)\ **Post date:** [May 8, 2013, 10:55pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/30 "2013-05-08T22:55:56Z")
> [@treis](#): > > Are you planning on simply ignoring my explanation while restating your original contention? I see your explanation and I don’t agree with the premises. For example, you say the company will price the offering at lower than current share price. That’s simply incorrect - DDD will price the offering at whatever the share price is tomorrow at end of market. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [May 8, 2013, 10:59pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/31 "2013-05-08T22:59:44Z")
> [@Terr](#): > > I see your explanation and I don’t agree with the premises. For example, you say the company will price the offering at lower than current share price. That’s simply incorrect - DDD will price the offering at whatever the share price is tomorrow at end of market. I said “in most cases”, and in most cases is true. The only exception to the rule is if demand is increased because the market thinks the stock offering will increase the company’s value. History has shown that typically isn’t the case. ---
**Author:** ![Terr](https://avatars.discourse-cdn.com/v4/letter/t/839c29/32.png) [@Terr](https://boards.straightdope.com/u/Terr)\ **Post date:** [May 8, 2013, 11:02pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/32 "2013-05-08T23:02:33Z")
> [@treis](#): > > I said “in most cases”, and in most cases is true. The only exception to the rule is if demand is increased because the market thinks the stock offering will increase the company’s value. History has shown that typically isn’t the case. It is not true “in most cases”. The company “in most cases” announces that it will price the offering at the current share price at a set date/time a day or two forward. The market then decides what the offering price is just like it decides what the share price is, every day. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [May 8, 2013, 11:03pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/33 "2013-05-08T23:03:54Z")
> [@Terr](#): > > It is not true “in most cases”. The company “in most cases” announces that it will price the offering at the current share price at a set date/time a day or two forward. The market then decides what the offering price is just like it decides what the share price is, every day. Which in most cases is lower than the price when they announce the sale. What is confusing about this? ---
**Author:** ![Terr](https://avatars.discourse-cdn.com/v4/letter/t/839c29/32.png) [@Terr](https://boards.straightdope.com/u/Terr)\ **Post date:** [May 9, 2013, 12:15am UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/34 "2013-05-09T00:15:05Z")
> [@treis](#): > > Which in most cases is lower than the price when they announce the sale. What is confusing about this? So it is not the company that determines the price, as you claimed. It is the market. Which is what the OP is about. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [May 9, 2013, 12:43am UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/35 "2013-05-09T00:43:08Z")
> [@Terr](#): > > So it is not the company that determines the price, as you claimed. It is the market. Which is what the OP is about. > [@treis](#): > > So like any other product, the price is a function of supply and demand. … ---
**Author:** ![Terr](https://avatars.discourse-cdn.com/v4/letter/t/839c29/32.png) [@Terr](https://boards.straightdope.com/u/Terr)\ **Post date:** [May 9, 2013, 12:50am UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/36 "2013-05-09T00:50:45Z")
> [@treis](#): > > … [QUOTE=treis] So if the company wants to raise money, in most cases they are going to have to price it at less than the current market price. [/QUOTE] … I have no problem with the idea that the market is what determines the offering price - markets are often wrong and correct themselves later. What perplexes me is that markets in case of stuff like shelf registrations _always_ react negatively, even if they then turn around in the same day. That initial negative - Pavlovian - reaction is what I an wondering about the reasons for. ---
**Author:** ![deltasigma](https://avatars.discourse-cdn.com/v4/letter/d/e5b9ba/32.png) [@deltasigma](https://boards.straightdope.com/u/deltasigma)\ **Post date:** [May 9, 2013, 12:59am UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/37 "2013-05-09T00:59:42Z")
I see that “follow-on offering” was mentioned a few times but I guess I was the only one who needed a fuller explanation. Sometimes it pays to be stupid I guess. 😃 > [@](#): > > In the case of the [dilutive offering](http://en.wikipedia.org/wiki/Stock_dilution), the company’s [board of directors](http://en.wikipedia.org/wiki/Board_of_directors) agrees to increase the share [float](http://en.wikipedia.org/wiki/Float_%28finance%29) for the purpose of selling more equity in the company. This new inflow of cash might be used to pay off some [debt](http://en.wikipedia.org/wiki/Debt_capital) or used for needed company expansion. When new shares are created and then sold by the company, the number of [shares outstanding](http://en.wikipedia.org/wiki/Shares_outstanding) increases and **this causes dilution of earnings on a [per share](http://en.wikipedia.org/wiki/Earnings_per_share) basis.** Usually the gain of cash inflow from the sale is strategic and is considered positive for the longer term goals of the company and its shareholders. Some owners of the stock however may not view the event as favorably over a more short term valuation horizon. The highlighted part explains the dilution and the following sentence explains why the effect is so short lived. The market tends to anticipate changes 6-18 months in advance. So if it believes that the additional cash can be immediately put toward highly profitable activities, it will see the dilution of earnings as temporary and respond accordingly. ---
**Author:** ![treis](https://avatars.discourse-cdn.com/v4/letter/t/bc79bd/32.png) [@treis](https://boards.straightdope.com/u/treis)\ **Post date:** [May 9, 2013, 1:29am UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/38 "2013-05-09T01:29:17Z")
> [@Terr](#): > > … > > I have no problem with the idea that the market is what determines the offering price - markets are often wrong and correct themselves later. What perplexes me is that markets in case of stuff like shelf registrations _always_ react negatively, even if they then turn around in the same day. That initial negative - Pavlovian - reaction is what I an wondering about the reasons for. So to reiterate: (1) If the supply of something goes up, the price will go down unless there is a corresponding increase in demand. (2) It is an indication that the company is having trouble raising money through debt. ---
**Author:** ![JustinC](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/justinc/32/8083_2.png) [@JustinC](https://boards.straightdope.com/u/JustinC)\ **Post date:** [May 9, 2013, 5:29am UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/39 "2013-05-09T05:29:21Z")
“Buy the rumour, sell the fact” is a well known saying which would fit the observation that the price of stocks fall upon announcements. If a trend appears then it’s often self-reinforcing, so when even good news comes out some will sell the stock because they think the price will fall. This is regardless of whether a secondary offering is dilutive or not. As to that, the company seeking money might use that to buy a competitor which would seem, at first, to be a good thing. But if the combined company has problems integrating it could be a problematic and expensive process. If the offering adds little value overall I would consider it dilutive, but how are we to know if without that decision the company would’ve continued to be successful? Then again, maybe gobbling up rivals using share offerings is the practice _du jour_ and, when the announcement comes, many more bought on the rumour and will sell, to lock in profits and people will buy as the shares look cheap. Who’s is right? “One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute.” William Feather ---
**Author:** ![Fotheringay-Phipps](https://avatars.discourse-cdn.com/v4/letter/f/d9b06d/32.png) [@Fotheringay-Phipps](https://boards.straightdope.com/u/Fotheringay-Phipps)\ **Post date:** [May 9, 2013, 6:04pm UTC](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814/40 "2013-05-09T18:04:13Z")
Some observations: 1. Stock prices drop even in response to non-dilutive SPOs, e.g. when the original private owners who went public in the IPO unload another big bunch of shares. It’s simply supply and demand. A huge number of shares coming on the market at one time will depress the prices even if nothing else changes. 2. SPOs are frequently (usually, AFAICT) done to raise money after-the-fact. IOW it’s not that the company issues a secondary and then turns around and invests that elsewhere. Generally they first make the investment using temporary bank financing, and then turn around and retire some of that debt through the SPO. But the numbers are not exact - it’s not as if they invest $1B and then issue a secondary for $1B. So there’s a lot of uncertainty whether the company’s current financial status - post any investments they might have done - requires an SPO, and if it does, how many shares will be issued. Once the company announces the SPO, that settles the question, and people who thought and SPO wouldn’t be necessary, or might not be necessary, or might be smaller, are all unpleasantly surprised. 3. Added to the above is that in the market perception is reality. Once everyone knows that secondary offerings depress the stock price, then that knowledge alone depresses the price, so it goes down even more than it would have in the absence of this knowledge. 4. Of course, companies issuing SPOs know all this. They also know that if they execute on their strategy then the results of the secondary-plus-investment will ultimately raise the share price. Even more importantly, they also know that even if the share prices never recover, the mere fact that the company is bigger - even if no more profitable on a per share basis - means that they, as senior executives, will be in line for bigger salaries and bonuses. So it all works out OK in the end, especially for the senior executives who make the decisions. If they execute, that is. But no one ever became a senior executive by walking around with the attitude that they might not execute on their plans. So that’s not really a consideration, for anyone making the decisions. And the beat goes on. [Previous page](https://boards.straightdope.com/t/secondary-offerings-and-dilution/657814.md?page=1)