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
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
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
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.
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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.