Allison Transmission Holdings (NYSE:ALSN) recently announced a super-sized secondary share offering of up to 23.8 million shares -- every one of which will be sold by existing shareholders, and not one of which will generate cash for the company itself. Actually, the contrary.
That's the upshot of this week's news. Not the fact that Allison increased the size of share offering by 25% (from an initially anticipated size of 16.6 million shares). Not the fact that Allison committed to buying back 4.7 million shares from the selling shareholders before these shares even hit the market. What's really important here is that:
- Allison will be no richer for the fact of these shares going on the market
- Allison will actually become poorer
- The people selling are insiders who want out of Allison
- They're right to want to want out
Let's take those one at a time. First off, the shares being sold under this offering are owned primarily by private equity firms Onex Corporation (TSX:OCX) and the Carlyle Group (NASDAQ:CG), which each own approximately 34.5% of Allison. As such, it will be Onex and Carlyle reaping the gains from this stock sale -- not Allison. Indeed, Allison must ante up about $100 million to take off the market the 4.7 million shares it has committed to buy back. So Allison is actually getting poorer, not richer.
As for the sellers, and why they want to (sell), these private equity firms are what are commonly referred to as the "smart money" in stock investing. With Allison shares up 30% off their lows of last September, Onex and Carlyle are getting out while the getting is good. But if the smart money is selling, the question is whether you should want to buy?
The answer, I think, is "no." Here's why. At current prices, Allison shares cost 35 times trailing earnings. Even with strong free cash flow, the shares command a steep "enterprise value" of 20 times trailing free cash flow, as well. Both of these valuations seem rather "optimistic," given that few analysts believe Allison can grow its profits faster than 15% per year over the next five years. Indeed, even with a modest dividend yield of 2%, it's hard to argue that Allison shares are even fairly valued at today's prices -- much less a "bargain."
Moral of the story: When the smart money is rushing to get out of a stock, don't crowd the exit door, rushing to get in.