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.
