Record levels of stock issuance by public companies over the past several weeks could come back to haunt the market and hurt investors, at least in the near term.
Record levels of stock issuance by public companies over the past several weeks could come back to haunt the market and hurt investors, at least in the near term.
While the market rally from the March 9 low has started to level off, the impact from the record $64 billion in shares issued in May could linger for months, according to market analysts.
Historically, when the stock market experiences a one-month infusion of $30 billion or more in stock issuance, the Standard & Poor's 500 stock index declines by an average of 4% over the next 90 days.
“It is absolutely dilutive to shareholders,” said Steven Roge, a portfolio manager with R.W. Roge & Co. Inc., a Bohemia, N.Y.-based firm with $180 million under management.
“We saw the first couple of good months in the market in almost two years, and companies that were strapped for cash used the opportunity to raise money,” he said. “But as you increase the supply of stock, the intrinsic value of each share goes down.”
The May flood of stock issuance represented a 68% increase over the previous one-month record of $38 billion, set in May 2008, according to TrimTabs Investment Research in Sausalito, Calif.
In the 90 days following May 2008, the S&P fell by 8.4%.
In the context of an extreme economic downturn coupled with a credit crunch, it is not a big mystery why companies turned so quickly to the equity markets for cash.
However, what is somewhat jarring is the way that the equity markets responded with such enthusiasm, according to Conrad Gann, president and chief operating officer of TrimTabs.
“It is still surprising how quickly they raised the money, and the magnitude of it,” he said. “It is puzzling as to why the companies issuing all that stock were so successful.”
The initial push in the recent issuance trend was sparked by financial institutions that needed to prove to the federal government that they are capable of raising cash, which was required before the companies were allowed to start paying back loans that came through the Troubled Asset Relief Program.
Many of these firms, including Bank of America Corp., BB&T Corp., Capital One Financial Corp., The PNC Financial Services Group Inc., U.S. Bancorp and Wells Fargo & Co., timed their secondary stock offerings to the market rally by seizing on a growing investor appetite for equities.
But as the market gobbled up the new shares, the issuance trend expanded beyond financials to include companies such as The Dow Chemical Co., pharmacy benefit management firm Express Scripts Inc. and Ford Motor Co.
“Every company now seems to want to pay down debt and build a cash cushion,” said Jeffrey Kleintop, chief market strategist with LPL Financial in Boston.
“It's a very uncertain environment right now, and companies are more concerned about making it through the next 12 months, as opposed to making the most of the next 12 months,” he said.
A large part of the appetite for new shares is being attributed to institutional investors who have seen the equity portion of their portfolios pulled out of balance by the stock market's downturn.
“Share issuance is very convenient for institutional investors, and they were glad to provide the capital,” Mr. Roge said.
Even as he recognizes the driving forces behind the recent pattern of secondary offerings, he is critical of the strategy, from an investor's perspective.
“We believe companies should raise capital the old-fashioned way — by earning it,” Mr. Roge said. “I'm not a huge fan of management teams' wasting shareholder capital and then going back to the shareholders for more.”
Although there are many cases that can be made for secondary stock offerings, including the need to raise capital as a step toward paying back TARP loans, the immediate result for shareholders is always dilution.
As opposed to a stock repurchase program, which reduces the amount of outstanding shares and usually increases their value, a secondary issuance can have the opposite effect on share value.
However, it is also important to consider that a secondary offering usually results in a better-capitalized company.
“As an investor, I would look at why a company is issuing the new shares,” said Uri Landesman, head of global growth in the New York office of Hartford, Conn.-based ING Investment Management Americas.
“A company might be raising the cash because it has a big debt maturity coming up,” he said. “Or it might be raising cash to make acquisitions, in which case I would consider the company's track record with acquisitions.”
The more likely scenario for most companies was a well-timed tapping of pent-up demand, according to Mr. Landesman.
“Companies decided they needed the capital or that they might need the capital,” he said.
One irony of the recent flood of stock issuance is that it barely touched the sleepy initial public offering market, which has seen only nine IPOs so far this year.
The three IPOs in May combined for a total of $450 million, which is less than one-tenth of 1% of the total new issuance for the month.
“This is an IPO market that has basically shut down for the past six months,” said Bill Buhr, an analyst with Morningstar Inc. in Chicago. “I think people are still a little fearful when it comes to IPOs.”
E-mail Jeff Benjamin at jbenjamin@investmentnews.com.
