When Secondary Offerings Get the 'Signature'

There are many reasons why firms decide to do secondary offerings. Before getting into those, let's define what secondary offerings are.

It's when a publicly traded company sells new -- or closely held -- shares. There are two types, and one is a non-dilutive offering, and the other is a dilutive one. In the first, a number of existing investors sell much of their equity stakes in the company and no new shares are issued. In the second, the company issues new shares to raise cash for the business, which dilutes the value of each individual share.

Sometimes there offerings come from strength, but many occur as a means of survival -- to stay out of bankruptcy. Travel-related firms like airlines, hotels, casinos and cruise operators have been forced to either borrow or issue additional equity simply to fund ongoing losses that appear to be nowhere near over.

Selling secondary shares will be dilutive if and when these firms start making profits again, hurting future earnings per share due to having more shares outstanding. The good news is that, unlike bond issuance, there is no need to pay interest on the money raised, or to ever make principal payments.

Adding millions of shares at below present-day book value lowers book value for all prior shareholders. Selling secondary shares out of desperation, is bad, but it still beats going through bankruptcy.

Well-run companies know it's best to "make hay while the sun shines."

They take advantage of optimistic, or over-optimistic, share prices to raise money when their stocks are popular and highly valued. Issuing new shares at times like that can raise big money to be used for general corporate purposes, future acquisitions or organic growth. Selling new shares above present-day book value makes that number go up, not down.

Unless companies are facing imminent bankruptcy, they can almost always get secondary share offerings done.

Why is that?

The process ensures buyers of the newly issued shares can make immediate, virtually risk-free gains if they choose to.

Underwriters like large brokerage firms typically guarantee to sell a particular quantity of shares to their clients, but at a nice discount to the 4 p.m. closing quote. Favored clients are given advanced notice of the pending offering and can sell, or short, the number of shares they plan to buy at that discounted price. That locks in an arbitraged gain that can be substantial.

Here's an example: Signature Bank of New York  (SBNY)  closed on Thursday at $183.50. If the secondary priced at a 3% discount, buyers knew they were would be getting their new SBNY shares at $178.00.

Shorting 10,000 shares last Thursday at $183.50, knowing you've already covered at $178.00, meant locking in a guaranteed profit of $5.50 per share or $55,000. Anyone with enough capital to make that commitment was gifted a hefty profit.

The underwriting firms got paid out of the proceeds of the offering. The buyers locked in risk-free returns if they chose to sell in advance, rather than wait to see what happened to SBNY shares later. As it turned out, Signature bounced back to finish $182.97 at 4 p.m. on Friday.

Life is not fair. Mom and pop investors are rarely offered this "free money." Instead major customers, who do big business with the underwriting firms, are being rewarded for their loyalty.

Let's look another example. When J.C. Penney (formerly JCP) was failing years ago it was still able to sell 84 million shares back in September 2013. That raised about $672 million, which kept them afloat for quite a bit longer than it otherwise would have been able to manage. 

Did the buyers of that offering like JCP's prospects? Did they see it as a good investment? Hell, no. They merely took their "free money" and left those 84 million new shares for the suckers who believed the company could stay alive.

Well thought out secondary offerings can be wonderful for both firms and existing shareholders. I wrote positively about Griffon's (GFF)  summer of 2020 share issuance. It helped fund an acquisition which is already accretive to EPS. GFF's book value increased, plus its balance sheet was improved. GEF is up about 20% since that secondary took place.

Back to Signature. Signature Bank's end of 2020 book value was about $109. Selling shares at $178, near the stock's all-time high, made that number larger. Previous shareholders got a benefit from that and trust that management will put the newly raised cash to good work.

The premarket, arbitrage-related, drop to $178.50 was a gift of sorts to anyone who'd wanted to buy SBNY the day before, but didn't choose to pony up over $183 for it. As noted earlier SBNY closed that same day at $182.97.

Barring a major overnight negative surprise, the underwriters' over-allotment of 525,000 was almost certainly going to be exercised as well. That represented additional risk-free money that could be soaked up by the underwriters themselves or allocated to preferred clients.

Real Money Pro subscribers know I recommended SBNY a few months back, at just $80.74. Those who took my cue have now more than doubled their money in just over three months. Interestingly, Value Line's rating system inexplicably called SBNY a sell at that time.

I also showed readers the juicy put premiums that were available for those bullish on SBNY last fall. Shorting Sept. 17, 2021 expiration date puts might have appeared aggressive back then, with the stock below $81.

Today, they look incredibly conservative. Worst-case, forced purchase prices were set at either $70.50 ($90 - $19.50) or $73.70 ($100 - $26.30). Collecting 100% of either $1,950 or $2,630 per 100-share commitment now appears extremely likely. It's too bad we can't force those put buyers to give us the shares.

The Sep. 17, 2021 $100 buy/write combination had a worst-case break-even price of $73.38. That also, seems laughable now. Total returns on that very conservative combination, though, were excellent. If SBNY merely holds at $100 or better through expiration day combination writers would have made 109.9% while assuming less risk than simply buying outright without the option sales.

In summary:

1. Secondary offerings can be a sign of weakness or a sign of strength depending on the reason for the transaction.
2. Previously existing shareholders can be helped, or hurt, when secondary shares are issued.
3. Smart management sells shares when they appear over-priced or fully priced.
4. Desperate management uses secondary offerings to stay alive, hoping to avert bankruptcy and position for an eventual rebound.
5. Buyers of secondaries often do so simply to take immediate, risk-free gains.
6. The fact that secondaries get done does not imply that the buyers of the shares think positively about the underlying company.

At the time of publication, Price was long SBNY and GFF shares, short SBNY and GFF options.