Share dilution is always bad, right? Not necessarily.
Case in point, LinkedIn's (NYSE:LNKD) proposed follow-on offering of $1 billion of shares.
"But borrowed money is so cheap"
Why would LinkedIn sell shares and dilute ownership instead of selling debt -- especially given today's low interest rates? That's the question a Bloomberg host posed to Bloomberg technology editor Ari Levy.
Though the concern is certainly merited, the answer is easy. Levy explained: "If there was ever such a thing as free money, this is really free money for LinkedIn. If you talk about the fivefold increase in the stock price, you know, they're able to sell a fraction of the shares they sold in the IPO -- less than half -- and bring in twice the amount of money."
LinkedIn, near its all-time high of about $248, is on a tear. In the past 12 months alone, shares are up about 120%. This gives LinkedIn an opportunity to take advantage of money that is far cheaper than it was just a year ago.
Is it worth the share dilution?
A $1 billion offering would boost LinkedIn's share count by about 3%. Though the dilution wouldn't be huge -- it's still meaningful.
Is the dilution worth an extra $1 billion on the balance sheet? The social network already has $873 million in cash. Isn't that enough? What value does this extra cash bring?
Essentially, LinkedIn is hedging a portion of its lofty valuation with tangible cash. The market is a forward-looking mechanism. And in LinkedIn's case, it's very forward looking, with enormous growth already priced into the stock. LinkedIn's decision to sell $1 billion of shares is a way for management to secure a portion of this confidence and beef up its arsenal with cheap money.
LinkedIn shareholders who believe in the stock's growth story may be disappointed, thinking that shares will continue to rise and money will just get cheaper for the company. Maybe they're right. But nothing is wrong with hedging a portion of investors' ecstatic confidence in the company by converting that confidence to usable cash. In the case of a downturn, a sinking share price can't take away the company's cash. Even more, the company has an opportunity to employ that cash in lucrative opportunities.
LinkedIn fortifies its position
When it's all said and done, another offering for LinkedIn shares doesn't boost upside opportunity, but it does help to buffer the downside by doubling the company's cash position. Taking into consideration both sides of the coin, that makes for an incrementally higher total expected value for both the business and the stock.
Fool contributor Daniel Sparks has no position in any stocks mentioned. The Motley Fool recommends LinkedIn. The Motley Fool owns shares of LinkedIn. 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.