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Recently some companies that I own stock in have made public offerings of common stock, some in the form of a “bought deal”. Can a company just create and offer more stock? Doesn’t this just dilute the value of the stock and hurt all current shareholders? Are there other ramifications of this action that are not obvious? Under what circumstances is this an OK thing to do?
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Sure, a company can do a secondary offering. An example of this is Google's secondary offering in 2005, where they issued 14 million additional shares at $295 a share, raising a little over $4 billion:

http://www.cfo.com/article.cfm/4416430/c_4418007?f=home_toda...

Companies may find themselves with a need for more money than earnings from operations can provide. At that point they have a choice to either take on more debt (if they can get it) or to issue more equity.

Many small, fast-growing companies find it difficult to get good terms on debt because they are inherently riskier firms than large, stable companies like Coke or Microsoft. Typically the only debt a small company has access to is bank debt; they are typically unable to issue bonds as no one is interested in taking on the risk of buying buying a bond from a small company with few assets that is cash flow negative. Bank debt typically is the least flexible debt in terms of repayment of principal, and the interest rate might be onerous for a small, cash poor firm.

So the other option is equity. Is it a bad choice? It depends. If the company is in need of cash to survive and/or grow and the company is unable to take on further debt, issuing equity might be the only choice.

Issuing equity might also be a good choice if the company's stock is fully valued or over-valued. Imagine a tech company in the late nineties that has never made dime in profit, but is in need of money. The company's shares might be worth $4.00 a share but are selling for $20.00 a share, 5 times what they are worth. In that case, issuing equity is a great choice since they are able to sell something for 5 times what it is worth and use the funds raised to grow the business.

Of course, it can also work the other way. In the depths of the recession back in February/March there were companies who issued more equity to raise funds from severely undervalued stock prices. Again, this was a case where likely there was no other option as the debt markets were essentially closed, but selling a $20.00 stock for $5.00 is like selling a brand new Ferrari for $50,000. Sure, it's a good chunk of money in the door, but it's a shame you needed to do the fire sale.

So in summation, yeah, it's dilutive, but whether it's a bad choice depends on why they are raising money, what their other options were, and at what stock price relative to intrinsic value the secondary offering was made.


Mike
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