Thanks to the post by dracoi, I see I am incorrect in understanding.
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.
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.
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.
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.
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.
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.
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.
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.
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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.
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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.
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. 
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.
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.
“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
Some observations:
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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.
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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.
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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.
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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.