These Equity Offerings Make Me Sick

Wall Street seems suddenly awash in follow-on stock offerings. The Wall Street Journal pointed out that last week set a record for $1 billion-plus offerings (by no less than eight different companies). This week, Bank of America (NYSE: BAC  ) held a $13.5 billion bake sale of its own.

Analysts at firms such as Goldman Sachs (NYSE: GS  ) refer to sales like the one just executed by B of A as "ATM," or "at the market," deals. Alas, it seems that cash-strapped firms and their investment banker friends view existing shareholders as a different sort of ATM. That's life at the bottom of the capital structure, I suppose.

With everyone from banks to real estate investment trusts (REITs) to oil wildcatters suddenly facing debts that their cash flows can't support, these spendthrift stewards are now using more expensive sources of capital, namely equity, to pay off the cheaper funds previously extended by their enablers, er, creditors. Those folks are of course having liquidity problems of their own, and are thus eager to pare away potential problem loans.

Hold this bag, would you?
Most of these stock sales are almost certainly designed to bolster the issuer's liquidity -- whether to position it as an opportunistic acquirer at best, or to merely remain solvent at worst. Lenders, however, are also benefiting big time, to the point where this almost starts to look like another, quieter sort of bank bailout. (Sorry to overuse the term, Morgan.)

Basically, busted banks hope to repair their loan books by offloading their credit exposure onto shareholders' shoulders. No one is forcing anyone else to buy these shares, as far as I know, so this situation isn't nearly as repugnant as the one in which taxpayers backstop the bondholders who financed such illustrious failures as the 35-to-1 levered Bear Stearns. But I still find it distasteful, especially in the instances where the underwriting banks' equity research arms kick in an upgrade on the stock, potentially creating some quick-flip profits in the process.

Let's look at a recent example from the oil patch, the area of the market that I monitor most closely. I'm not even going to talk about one of those deleveraging disasters that I recently documented. We've seen much more noxious offerings in the space, but this fresh deal does reveal just how little shareholders have to cheer about.

If a share's issued in the Forest...
Forest Oil (NYSE: FST  ) , an oil & gas independent, boasted of a strong balance sheet at a UBS AG (NYSE: UBS  ) Conference on Tuesday. That very afternoon, the company then turned around and initiated a sizeable stock offering.

To be clear, Forest Oil isn't in nearly as tight a spot as many of its peers. The firm already had a good chunk of availability under its $1.6 billion in revolving credit lines (a combination of U.S. and Canadian bank credit facilities), but the offering's stated intent is nevertheless to pay down those low-cost borrowings further.

How low-cost are we talking? The $800 million drawn on the U.S. facility recently sported an interest rate of 1.7%, while the Canadian borrowings cost 2.1%. Forest Oil's cost of equity, meanwhile, is certainly far higher -- it's just not as palpable as a cash interest payment.

I think that's exactly what inclines a company to pull the share-issuance trigger when liquidity gets tight. It's a quick and dirty solution, and you only run out of bullets if your stock price collapses completely. Thus Forest Oil's share count will balloon by 13% to 15%, depending on the underwriters' overallotment exercise. At least it's got cash to weather the storm, right?

Banks bail while you buy
Meanwhile, the bankers are reaping multiple benefits under this deal and similar ones. Of course, there's the fee income tied to underwriting the offering. There may be a spread between the underwriting price and the subsequent price, if the offering is received warmly. Finally, there's the offloading of credit risk this debt-for-equity swap enables.

In both the case of Forest Oil and Penn Virginia (NYSE: PVA  ) , there's even some overlap between the underwriters and the lenders, with more than 10% of the net proceeds of each offering going to pay off affiliates of the underwriters. Penn Virginia thus identifies a possible "conflict of interest" between itself and JP Morgan (NYSE: JPM  ) and Royal Bank of Canada (NYSE: RY  ) in its prospectus.

To be clear, I'm not calling this a conspiracy by the banks to dupe investors into lapping up all this new equity. The recent rally in the market is really all it took to get Wall Street's animal spirits, and the buy orders, flowing. But further down the road, I can't help but wonder whether today's newborn bulls will feel like they've been burned. (That skepticism's colored by my own views on the sustainability of this market rebound, which I haven't been shy about sharing with my fellow Fools.)

Fools, think hard about why you should buy into all these share issuances when the banks are trying to cut and run. And consider whether you really want to invest alongside a management team that's using an equity offering like an escape hatch.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile, or follow his articles using Twitter or RSS. The Motley Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (39)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 21, 2009, at 4:35 PM, TMFHousel wrote:

    You're excused just this once.

  • Report this Comment On May 21, 2009, at 5:48 PM, 102971 wrote:

    Very good article and most apt. Any one who subscribes for these equity offerings is a fool. Not a Motley Fool just a plain FOOL.

  • Report this Comment On May 21, 2009, at 7:01 PM, Fliujniligui wrote:

    I agree with your post. In this optic, I only buy shares of the ones who managed sufficiently well to be well capitalized and not in need to get further capital. National Bank of Greece, Activision Blizzard, Titanium Metals, Deutsche Bank...

  • Report this Comment On May 21, 2009, at 10:49 PM, jesse2159 wrote:

    Did anyone actually believe that bankers' little evil minds were not going to try again to lure the rubes to slaughter? There are shades of truth. But bankers don't even pretend any longer. They lie with relish.

    Just after the mark-to-market rule was suspended, banks were in the black again, stocks jumped 30% and everyone was above average in looks. If you seem concerned that it doesn't make sense, you are correct. Nothing as big as the national economy turns that fast. In five months we will see who is right.

  • Report this Comment On May 22, 2009, at 6:30 AM, sherbo1 wrote:

    OK, just go back to the comments that the MFs published on May 7th following SWHC issuance of 5.5m shares.

    I quote " Debt + Dilution = Delicious, why SWHC looks better than ever right now" Wow.

    The real fool is who takes such contradicting opinions seriously.

  • Report this Comment On May 22, 2009, at 6:52 AM, Mouse574 wrote:

    I am surprised at this article because normally fool writers avoid the mistakes of other writers through better research and better explaination of financial terms. That being said, this article falls far short. I understand the desire to look for a scapegoat when the economy turns south and banks are a logical target, but let us at least get our facts straight on equity offerings from some of the largest banks.

    1. Many of them would not be sellings shares (and diluting existing shareholders) if not for the government stress tests requiring additional captial.

    2. It is important that we make the distinction between capital and liquidity. Given the current environment (both economic and political) banks are holding plenty of excess cash. Most of the large banks are being asked to raise capital not because they do not have cash/liquidity but because the government has asked them to increase their capital cushon to protect against losses.

    3. Keep in mind that MOST of the stress tested banks DID NOT NEED ADDITIONAL CAPITAL. They were asked to change their mix of capital to include more common capital vs. preferred.

    I think it would be helpful to share an article that breaks down some of these facts in typical "foolish" fashion so that fellow fools can sift once again return to this site to be educated, not read rhetoric from bandwagoners looking to broadly blame the big banks for all the worlds economic problems.

  • Report this Comment On May 22, 2009, at 11:17 AM, Andyman wrote:

    You keep saying the banks don't need the capital, as if we are confused about something. The money is not for the banks. The money is for businesses and consumers to borrow in order to thaw the credit freeze.

  • Report this Comment On May 22, 2009, at 11:39 AM, Pbomb wrote:

    Ok the headline is clearly hyperbole, but a little bit over the top nonetheless.

    Let me ask you what you would do as a CEO of a company in the current environment where many other companies in the past 12 months who have not raised equity when it was available have had credit facilities called or significantly reduced or have been unable to renew such facilities? Do you think you would be acting in the best interests of shareholders by not seeking additional equity capital when it was available when it is possible that in 6 months you may not have that same access to the equity market and the credit markets may again be inaccessible? I think such a CEO would be criticized for not accessing the equity markets just 6 months earlier to maintain greater financial flexibility.

    Finally, I do not think people that buy shares under these offerings or on the open market in an ATM deal deserve some special kind of sympathy if it turns out to be a bad investment - if you cannot judge an investment on its merits and face the consequences of the risk you are taking you should not be investing in the market in any event.

  • Report this Comment On May 29, 2009, at 7:50 PM, wecwec33 wrote:

    I 'felt' it coming in Jan-Feb 2007, and began to slowly 'cash out'. What I have is mine, earned by my own sweat and vision. I lost a total of 2.2 % ending 31 Dec 2008, and now they want me to invest in their firms, when they know NOTHING about managing assets, and the 'stewardship' for the employees, bondholders, and stockholders is non-existant. Go fleece someone else, it won't be me. You want me to 'loan' my monies to others who can't or won't even make the attempt to pay you back, why should I? Some of these companies have used the very government ( all of us) as a shield for their own mistakes, instead of doing what is mandated by law, that is a 'delaying' tactic, something I don't favor. Now, it is time to face you 'music' and play for your supper, I want the money upfront, and PROOF that you actually KNOW what you're doing. What a laugh, you actually know.....................I don't think so.

  • Report this Comment On May 30, 2009, at 11:26 AM, KAL64 wrote:

    blame it all on the banks....the crisis did not begin with the banks. it began with the bush administration's deregulation of the industry and the ridiculous notion that every american family should own a home.

    there are plenty of U.S. banks worth owning, especially at today's prices....just do the math.

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