Friday, September 18, 2009

Different Reactions to share sales (SXCI, VVUS, FSP)

AlphaNinja - This huge 50%(ish) stock market rally has resulted in dozens if not hundreds of follow-on offerings of company shares - companies are seeing their stocks flying, so figure why not raise some cash. Not a bad idea at all, but it's amazing the different receptions that these offering are met with.

Today you have SXC Health Solutions(SXCI) and Vivus (VVUS) stocks up 10% after announcing share offerings, while REIT Franklin Street Properties (FSP) is off 12% on news of their share sale.

The main reason for different reactions to stock sales is management - both the quality of management and their intentions for the cash raised. The decision to dilute existing shareholders must be undertaken prudently - if management is skilled then the money raised can be put to very shareholder-friendly use.

Below is a quick little example of a company issuing stock. Their reason was to increase the cash balance for debt retirement and potential acquisitions. The reason I highlight it is because the whole exercise is just a re-arrangement of the capital structure - aside from reducing interest expense (thanks to retiring debt), profitability was unchanged. Now the company has lower earnings-per-share, but they have more cash-per-share. The fundamental valuation is little changed. In fact, if they sold new shares at a discount as in this example, the stock is now cheaper, not to mention less risky without that debt.

Capital-structure changes from adding debt or selling shares can benefit or hinder a company, and the result is usually a testament to management's ability to allocate capital advantageously.

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