Secondary Public Offerings

A secondary public offering (SPO) is an issuing of common shares after the company’s initial public offering (IPO). Secondary offerings are also called follow-on offerings or follow-on public offers (FPOs). 

A secondary public offering is different from an initial public offering (IPO). An 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.

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?

SPOs occur as one of two types: dilutive and non-dilutive. The basic difference is what happens to the stock’s price per share as a direct result of the SPO.

In a dilutive secondary public offering, new common shares are created and offered for public sale. 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.

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.

A non-dilutive secondary public offering is essentially a private sale of common shares. In a non-dilutive SPO, a large shareholder, or a group of major shareholders, sell all or some of their holdings. The proceeds from this sale go to the 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). This is why this type of secondary public offering is considered a non-dilutive event.

With that said, there are times when a stock’s price may fall after a non-dilutive SPO, but that is due to normal market activity, not because the number of shares has increased.

There are many reasons why companies issue secondary public offerings. However, at their core, secondary public offerings are an attempt by a company to raise capital. And investors should seek to understand why.

Let’s consider some examples. Crispr Therapeutics (NASDAQ: CRSP) finished pricing for a secondary public offering on July 1, 2020. This wasn’t the first SPO 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 a 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.

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”. Investors may see their investment go down initially (if the SPO is a dilutive event) but if the underlying business is sound then the stock will have a chance of making up any loss and surging forward over time.

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.

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 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 a 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).

Obviously knowing when a secondary offering is coming 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 a 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.

Secondary offerings are hard to access because they happen very quickly. Even underwriters can have a hard time lining up buyers. In fact, 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.