Will This Stall the Market Rally?

Last week, at least 15 publicly traded companies announced plans to issue nearly $7 billion worth of shares, according to Reuters. Normally, you'd expect that news to concern investors, but this year has been anything but normal.

That $7 billion is a mere drop in the bucket compared to the amount raised already this year. Through the first eight months of 2009, there were more than 300 secondary offerings of common stock, with total issuance approaching the $100 billion mark.

What, me worry?
That $100 billion is a staggering amount of new supply. Yet the market not only absorbed it without a hitch but also vaulted sharply higher. Many companies, including Freeport-McMoran (NYSE: FCX  ) have seen shares double or more since doing secondary offerings earlier this year. Ironically, I believe those secondaries deserve a lot of the credit for the higher prices of many stocks -- and based on that, I think another $7 billion of stock won't cause any major problems.

Now, I recognize that secondaries are usually not viewed as being shareholder-friendly -- after all, they dilute existing shareholders. But keep in mind that companies get something for that dilution. Secondaries raise cash for companies, and that cash can be used for worthwhile purposes, including financing new capital projects, making acquisitions, or paying off debt. For many companies this year, getting that cash was important enough to investors to offset the negative impact of dilution.

Wait a minute. Secondaries actually helped fuel the rally?
Yes, as I see it, issuing new shares and diluting shareholders even though many stocks were trading at multiyear lows actually helped contribute to higher stock prices. Here's why.

In late 2008 and early 2009, many companies were on shaky ground and sinking fast. Balance sheets were overflowing with debt, and the credit markets were in such disarray that even companies with good credit couldn't get financing. As a result, many companies were unable to refinance maturing debt, a situation that caused the market to question how long those companies could survive. Without the ability to refinance or issue new debt, companies resorted to issuing stock to raise cash and pay off maturing debt.

Raising cash turned out to be a good move. Financial institutions such as American Express (NYSE: AXP  ) and JPMorgan Chase (NYSE: JPM  ) were able to improve their capital ratios and pay the government back for its TARP assistance earlier than anticipated. While the financials received much of the press because of the Federal Reserve's stress tests, non-financial companies such as Alcoa (NYSE: AA  ) , which was one of the first big companies to issue new shares back in March, and commercial real estate companies such as Simon Property Group (NYSE: SPG  ) and Vornado Realty Trust (NYSE: VNO  ) also benefited a great deal from raising cash to repay debt.

And the market's giddiness toward the secondaries remains intact. As of Sept. 9, of all the companies that held secondary offerings earlier this year, more than three-quarters had their stocks trading above their secondary offering prices.

Too much of a good thing?
If a company does a secondary offering for good reasons, such as paying down debt to reduce financial risk, then stock prices can rise. The stock market rally and economic recovery we've seen have come about in part from the help that hundreds of companies have gotten this year to improve their balance sheets.

However, you can still find some secondaries that shareholders don't like. For example, Green Mountain Coffee Roasters (Nasdaq: GMCR  ) announced a secondary in early August, and its stock price sold off on the news even though the company said it would pay down debt with some of the proceeds. The key difference was that Green Mountain isn't seen as a major credit risk, and so investors interpreted the decision as a sign that management thought its stock was overvalued and was looking to cash in.

This situation bears some watching in the months ahead. If we start seeing more secondaries from companies that are simply trying to take advantage of higher stock prices, then that could be a sign of a coming market top. For now, though, it appears that secondary offerings are doing more good than harm.

For additional reading:

Fool contributor Rob Plaza, CFA, owns no shares in any of the companies mentioned in this article. Green Mountain Coffee Roasters is a Motley Fool Rule Breakers recommendation. American Express is a Motley Fool Inside Value pick. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (10)

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 September 18, 2009, at 4:28 PM, wuff3t wrote:

    Rob,

    Haven't seen your name before, so just wanted to say thanks for the article. I'd never thought of things this way before (secondary offerings being a positive sign as companies raise new capital under otherwise difficult conditions), so thanks for broadening my understanding of the investing world. I've been wondering why some of my investments have seen an increase in their share price following the announcement of a new offering - now perhaps I know why!

  • Report this Comment On September 18, 2009, at 7:34 PM, CoffeeExplosion wrote:

    Recently, the stock market has put together the best five week run since 1938. Although this was due to extremely oversold conditions, the sentiment has turned cautiously bullish. The consensus seems to be that the economy will pick up later in the year, or by the first quarter of 2010. I suppose the question is whether or not this enthusiasm is justified.

    The financial stocks have been leading the way, with many having doubled or tripled from their previous lows. I am concerned that they are not out of the woods yet. The next shoe to drop will be commercial real estate followed by consumer credit.

    Let's look at Las Vegas. As bad as things are there, indicators say that they have not bottomed out. Recently completed commercial buildings sit with 65% vacancy rates. Unemployment is already double digit and is certain to rise over the next few months. This will put a strain on residential real estate, which has already seen price drops of more than 50% in some areas of Las Vegas.

    ------------------------

    Money is like muck, not good except it be spread.

    http://www.topinvestingtips.com

  • Report this Comment On September 20, 2009, at 10:48 AM, heat4seeker wrote:

    and could u tell me what 15 companies are doing this

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 987674, ~/Articles/ArticleHandler.aspx, 12/20/2014 12:55:47 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement