secondary public offering (SPO) is the sale of new or closely-held shares by a publicly-traded company that has already had an initial public offering (IPO). Non-dilutive secondary offerings occur when a major shareholder of a company sells a large portion or all of their holdings. In this scenario, the proceeds from this sale are paid to the shareholder that divests from the company. A dilutive secondary offering involves the creation of new shares and offering them to the public for sale. In this scenario, the proceeds from the sale are given to the company for future growth and expansion.What every investor needs to understand about secondary public offerings.
Over the last several months, you may be hearing about companies conducting secondary public offerings. There are many reasons why companies issue secondary public offerings and that’s an important point for investors to consider. Because at their core, secondary public offerings are an attempt by a company to raise capital, which should always raise the antenna of investors.
Let’s consider some examples. Crispr Therapeutics (NASDAQ:CRSP) finished pricing for a secondary public offering on July 1, 2020. And this isn’t the first of these offerings the company has undertaken.
For those who are unfamiliar with the company, Crispr is one of the leading companies in the field of gene editing therapy. It’s a fascinating field with tremendous potential to alleviate pain and suffering. But, that doesn’t’ come cheap. Nor does the company have any products bringing in revenue. So from time to time, the company uses secondary offerings to raise needed cash.
Then there’s a company like Denny’s (NASDAQ:DENN) that also announced pricing for a secondary offering in July 2020. The venerable restaurant chain was initiating the SPO for “general corporate purposes.” That could mean a lot of things, but more than likely it means the company is either using it to pay down existing debt that it took on as a result of the national shutdown. Or, more worrisome, it’s using the offering to keep the company going as the pandemic continues.
As you can see, the reasons for each offering may give investors a very different opinion about owning the stock.
And that’s maybe the key takeaway about secondary public offerings. They’re a common tool used by publicly traded companies to raise capital. But they can have a dilutive effect on a company’s stock. And that’s why a secondary public offering should always get a shareholder’s attention.
Introduction
A secondary public offering (SPO) is an event in which a publicly-traded company sells new or closely-held shares after its initial public offering (IPO). SPOs occur as one of two types: non-dilutive and dilutive. In a non-dilutive offering, one or more of a company’s major stockholders sells all or a large portion of their stock holdings. The proceeds from this sale go to stockholders that sell their shares. In this way, there is no addition of common shares. In a dilutive offering, new common shares are created and offered for public sale.
In this article, we’ll take a closer look at secondary public offerings. We’ll define the two types of secondary public offerings and how they are different from initial public offerings (IPOs). We’ll also take a closer look at why they can have a dilutive effect on the share price. We’ll also take a look at some of the potential risks of SPOs and things that are happening that can alert you to when a secondary public offering may be coming.
What is a Secondary Public Offering?
A secondary public offering (SPO) is, as the name suggests, a secondary issuing of common shares after the company’s initial public offering (IPO). Secondary offerings are sometimes referred to as follow-on offerings or follow-on public offers (FPOs).
A secondary public offering can be positive or negative for investors. The two factors that investors need to research are first what type of secondary public offering it is, and second what are the reasons for the offering?
What are the Two Types of Secondary Public Offerings?
As we mentioned in the introduction the two types of secondary public offerings are non-dilutive offerings or dilutive offerings. The basic difference is what happens to the stock’s price per share as a direct result of the SPO.
A non-dilutive event is sort of like a private sale of common shares. In this case a large shareholder, or a group of major shareholders, sell all or some of their holdings. The proceeds from this sale go to stockholders that sell their shares. In this way, there is no addition of common shares (i.e. the company has not increased the amount of stock that is held by investors).
Yes, there are many times when a stock’s price may fall after a non-dilutive SPO, but that doesn’t make the SPO a dilutive event. Sometimes investors may need some time to discern the reasons for the SPO.
On the other hand, a dilutive offering is always going to inherently affect the underlying stock price. To understand why, let’s take a closer look at what a dilutive offering is and why it will directly result in the lowering of a company’s share price.
What are dilutive offerings and why can they be bad?
In a dilutive offering, new common shares are created and offered for public sale. The price of a company’s stock follows the general formula:
Net income – dividends/outstanding common shares
If the denominator increases significantly, simple math dictates that the overall price per share will go down. In other words, it has a dilutive effect. A shareholder has not sold any shares, but the value of their holdings (on a per-share basis) has decreased.
How are Secondary Public Offerings Different From Initial Public Offerings?
An initial public offering (IPO) is an event that takes place when a company begins to trade as a public company on a U.S. exchange. Because a company that is undertaking an IPO does not have a trading history, the process is a lengthy one. The three basic stages of the IPO process are the underwriting stage, the filing stage, and the registration stage. If handled properly, an IPO should take between six and nine months.
By contrast, an SPO can be done much faster, usually in just days. In an SPO, spot or overnight offerings are announced at the end of a trading session and allocated to investors in just a few hours. A typical SPO is priced below the stock’s last closing price. This means, that unlike an IPO, investors have a fairly good idea of what demand will be for the offering because the price is generally considered attractive.
What are the Benefits to a Secondary Public Offering?
If the SPO is being offered to fund growth, it can offer shareholders an incredible opportunity for capital growth. The phrase that comes to mind is “short-term pain but long-term gain”. Although investors may see their investment go down initially (if the SPO is a dilutive event) in general, the stock will have a chance of making up any loss and surging forward.
Keep in mind, this is not advocating an idea of “catching a falling knife.” There are times a stock is falling with good reason. And when it is, as will be discussed below, it is usually better to stay away. However, when a company’s stock is rising, an SPO can help fuel additional growth which is a win-win situation.
What Are the Risks of a Secondary Public Offering?
In general, secondary public offerings can offer shareholders a benefit. But there are two basic risks. One is based on the company’s fundamentals and the other is based on technical price movement. Fortunately, both are simple to understand and avoid.
The fundamental risk comes from why the money is being raised. Many companies initiate SPOs to fuel expansion projects such as buying another company or building out the infrastructure that will ultimately allow them to grow market share or become a significant player in a new market. If this is the case, secondary public offerings can give investors a chance to get in on the ground floor of growing stock.
On the other hand, an SPO may be needed to address liquidity concerns. In this case, buying the stock may be incredibly risky because there is no guarantee that the company’s stock will bounce back.
From a technical perspective, SPOs are generally not very attractive for day traders and other active traders. This is because while a secondary offering can give investors a benefit of buying shares at a discount to the market price, there is a chance that the stock may open below the SPO price the next day (as mentioned above, this can occur even if the intent of the event was to be non-dilutive).
How Can Investors Know a Secondary Public Offering is Coming?
Obviously information is power. So knowing when a secondary offering is being planned would be a huge advantage for both buyers and sellers. But are there ways to know when a company may be planning to make an SPO?
Well, like market timing itself, there is no perfect way to know. However, there are some typical times when an SPO is more likely. First, an SPO may occur when the lock-up period ends after an IPO. Keep in mind, after an IPO there is generally a 3- to 4-week period when company insiders and institutional investors are prohibited from selling their stocks. However, after this period ends, it’s not uncommon for these insiders to sell shares in a non-dilutive offering.
Another timing indicator may occur when a company that historically underperforms the market sees their stock price increase due to heavy trading volume. The company may make a dilutive offering to take advantage of the conditions to raise equity. On the other hand, major shareholders may take the opportunity to reduce their holdings (sometimes in anticipation of a falling price).
A third indicator is the company's own history. The reality is that many companies conduct more than one SPO. Knowing if a company has a pattern of conducting SPOs can help you identify when another one is coming.
A final timing indicator may be when a company is in a period of financial distress. The novel coronavirus has created the need for many companies to find ways to raise equity quickly. If the company finds it difficult to borrow money from the debt markets, a secondary offering may be their only recourse.
It is always up to the individual investor to understand the when and why surrounding a company’s pursuit of an SPO.
How Can Investors Access an SPO?
The short answer is to know when one is coming. That’s because secondary offerings happen very quickly. Underwriters can have a hard time lining up buyers. It can be difficult for retail investors to even hear of them. MarketBeat.com features a Secondary Public Offering calendar that shows when companies are scheduled to issue an SPO. This is yet another feature that makes MarketBeat a one-stop resource for investors.
The Bottom Line on Secondary Public Offerings
Secondary public offerings are a relatively common occurrence. When they are done with growth intentions, they give major shareholders a chance to cash out of their investments while allowing individual shareholders to snap up shares of a growing company. Even when an SPO is a dilutive event, it can still be a wise investment for astute investors who are confident that the fundamentals of the company are solid.
This doesn’t mean that secondary offerings are without risk. They can be risky simply because a company may be initiating an SPO because they need to raise quickly due to poor liquidity. In this sense, an SPO may be their only alternative because they are unable to raise debt through standard outlets. In this case, an SPO may give the stock a short-term boost but will turn out negatively for shareholders unless the company fixes its underlying problems.
