Beware the Secondary Offering, or Not

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Green Mountain Coffee Roasters (Nasdaq: GMCR  ) had a good thing going until yesterday. Its Keurig single-cup coffee brewers and high-margin K-Cup refills are selling briskly. Earnings flew through the roof last week, and shares have more than doubled since being recommended to Motley Fool Rule Breakers subscribers less than five months ago.

So what exactly happened yesterday to send the stock 4% lower on an otherwise buoyant market day? Well, Green Mountain announced plans to sell 4 million shares in a public offering. Secondary offerings are rarely popular with investors. They dilute shareholders, decreasing their stakes in a company by the number of freshly minted shares.

The more problematic nature of secondary offerings is the message they send to investors. Just as insider selling often seems to signal a lack of faith in near-term capital appreciation, shareholders will question the timing of any secondary offering. What does the company think? Do executives feel that the stock has peaked? A company wouldn't be serving its investors properly by printing new shares at today's prices, if its board feels that the stock will trade even higher in the near term.

Of course, secondary offerings aren't death sentences. JetBlue (Nasdaq: JBLU  ) is trading well above its secondary offering price of $4.25 a share from two months ago. Discount broker E*TRADE (Nadaq: ETFC) also rose above its June offering at $1.10 a share.

However, even when things go well, shareholders have a legitimate beef. If JetBlue or E*TRADE had waited for higher stock prices, they would have been able to either raise more money, or simply offer fewer shares.

So secondary offerings stink, for the most part. However, every offering needs to be evaluated on its own.

A watered-down cup of coffee
The Green Mountain secondary is substantial. When you have roughly 40 million shares outstanding, tacking on another 10% to the share count is significant.

Green Mountain has its reasons, though:

  • Some of the proceeds will go to pay down the company's debt. Its leverage has always been manageable, but cleaning up its balance sheet will improve net margins.
  • The company's previous acquisition of Keurig -- and more recently Tully -- proved shrewd. Armed with cash, Green Mountain will have greater haggling flexibility if it decides to snap up some of its K-Cup brand partners, such as Diedrich Coffeee (Nasdaq: DDRX  ) or Caribou Coffee (Nasdaq: CBOU  ) .
  • Given Green Mountain's ability to profitably deploy capital and the high valuations assigned to that profit (53 times currently), investors might expect that any dilution will quickly be negated by higher profit.

So I forgive you, Green Mountain. Just don't rain on your own parade again.

Other caffeinated sips:

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Green Mountain Coffee Roasters is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletter services, free for 30 days.

Longtime Fool contributor Rick Munarriz doesn't fancy himself much of a coffee drinker, even though he lives within walking distance of three different Starbucks locations and has owned a Keurig machine for two years. He does not own shares in any of the stocks in this story. The Fool has a disclosure policy. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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