I have two rules for avoiding dreaded dilution in my stock investments. Rule No. 1: Seek out financially sound companies, because companies with cash will not sell additional shares to raise more cash. Rule No. 2: Forget rule No. 1.
Confused yet? Allow me to explain.
Don't dilute me, bro!
Natural-gas vehicle companies are familiar with financial distress. Companies like Westport Innovations
Fuel Systems Solutions has one of the best balance sheets in the industry with plenty of cash on hand ($75 million). There is absolutely no way this company would raise money via a stock offering, right? Wrong. Fuel Systems Solutions recently issued 2 million shares, raising $56 million in the process. What's next, Warren Buffett applying for a home loan?
Talk about a head-scratching moment. This move defies conventional wisdom by shattering the assumption that financially sound companies operate in a dilution-free zone. But is dilution always a bad thing for investors? It depends on what the cash is for. Read on.
Straight cash, homey
In a recent press release, management provided potential uses for the cash: working capital, repayment of debt, and acquisitions. Gee, thanks for narrowing it down, guys. Let's see if I can provide some clarity.
With a current ratio of 2.5 and annual positive cash flow of $70 million, Fuel Systems Solutions does not appear to need additional working capital, so that theory is out. Its debt totals $17 million, but it raised $56 million. Why would you raise $56 million to pay off $17 million in debt? You wouldn't, so the debt's not it, either. So what does that leave? Yep, you guessed it. An acquisition.
Dilution might be the right solution
My guess is that Fuel Systems Solutions is fishing for a U.S. competitor in case any favorable legislation is passed (see: NATGAS Act). If my theory is correct and it comes around, this will be the company's third acquisition in the last year. A growth company with an appetite for acquisitions? Sounds a lot like Microsoft in the early '90s (I'm just saying).
This could be a market anomaly in which dilution is actually good news. Stay tuned, the Q4 conference call may provide answers.
Fool contributor Adam J. Crawford owns shares of Fuel Systems Solutions but does not own shares of any other company mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.