Stock Market craziness

December 21, 2010 6:30 AM

StockmarketNOOBfilter. A company issues direct shares of common stock to institutional investors at 20% below previous day price - good or bad for the investor who already owns that stock?

I'm not very savvy with the stock market (obviously), but I've got about 10-15% of my Roth IRA tied up in stocks that I research and buy on my own. I research a bit, listen to advice from more savvy friends, and take into account economic trends and so forth. I've been pretty successful, all things considered, but the one investment where I got really burned was this company whose stock would go up, they would issue shares at a reduced price (driving the share price down), the stock would climb back up, they would issue more shares, stock would climb, then they'd spike it again (repeat about 5 times) until the stock was trading at about 25% of what I put in, so I backed out. Currently I'm holding a stock I really like, and it's performed fantastically for me in the last four months or so I've held it, but they just issued (this morning) over 3,000,000 new shares at 20% below current market price. On the one hand, I can see this as a good thing, as the company will have more working capital and can continue to grow. On the other hand, I just lost 20% of that stock's value overnight. Plus, I'm really skittish now when a company does this and am wondering if I should just jump ship now. Is this a trend I should be wary of, or is this really more company specific and it's not conclusive either way?

posted by (Arsenio) Hall and (Warren) Oates to Work & Money (28 answers total)

What you are talking about is called dilution. It is bad for people who already hold shares in the company at the time new shares are issued.
posted by procrastination at 6:31 AM on December 21, 2010

bad - you just got diluted. Why did they issue the equity? Was the B/S shot? in which case they might be bailing you out and its actually not terrible. But in any circumstance when other sources of capital would be available its a negative. More importantly, and I think you get this - what does it say about the people running the show.

Frankly w/o knowing the ticker its hard to say (this is not a request for a ticker, as I think stock specific advice on MeFi is iffy.)

If its a real business you don't need to raise equity for working capital. You might for fixed asset investment, but even then I would question it.
posted by JPD at 6:34 AM on December 21, 2010

If you're not very savvy to the stock market you shouldn't have 10-15% of your IRA tied up in stocks you are hand picking. This is one of many reasons. Look at an index fund.
posted by bitdamaged at 6:39 AM on December 21, 2010

Response by poster: Yeah, well, I kinda know it's bad for investors who own the shares now. I guess what I'm wondering, and maybe it's not possible to know, is if a company that dilutes their stock once will continue to do it? It seems like it would scare off investors. Have companies successfully used dilution and then gone on to perform fantastically? Is it typically seen as a good sign (the company is growing), typically seen as a bad sign (the company needs money), or typically seen as neither good or bad, but rather good or bad depending on the specific fundamentals of the company. I'm just confused because this company doubled its stock price in the last three months and has gone up about 30% in the past few days. Now this. It's confusing.
posted by (Arsenio) Hall and (Warren) Oates at 6:39 AM on December 21, 2010

Response by poster: If you're not very savvy to the stock market you shouldn't have 10-15% of your IRA tied up in stocks you are hand picking.

Well as I said I've already doubled this stock so if I bail I'm still doing okay. Plus I made some good investments and at this point I feel like I'm young and, since I'm playing with house money, can use the profit from those investments to invest in some high risk/reward stocks. Also, I should have mentioned that I was interested in holding this stock long but for reasons already mentioned by others I'm wondering if I should get out now if this is a sign of poor management or tomfoolery.
posted by (Arsenio) Hall and (Warren) Oates at 6:43 AM on December 21, 2010 [1 favorite]

I invest in equities for a living. If a company I owned was up a lot, had a reasonable b/s, and no near term liquidity sold a bunch of stock my immediate assumption would be that management and the board thinks the stock is expensive. The fact they sold it to institutions at a 20% discount w/o any outward sign of financial distress would freak me out even more. My first assumption would be some sort of fraud is going on. Whom did they sell the shares to? Is there any relationship between those people and the board?

Really its impossible to generalize. They could also be selling the stock to buy another company in which case the question is a function of the price they paid for that.

But in general, companies that issue lots of stock under any circumstance underperform.
posted by JPD at 6:48 AM on December 21, 2010

sign of poor management or tomfoolery.

Probably poor management, and if you've already doubled your money...
posted by josher71 at 7:14 AM on December 21, 2010

Not necessarily a big deal, and I wouldn't think anything of it unless there are other factors. If the stock is up substantially (as you say it is), and the market is hot (as it currently is), raising money (even at a discount, which is typical to get institutions in in size) is normal for a growth company, all things being equal. Especially if the company has a small number of shares out, making it difficult for institutional buyers to get in. You want big institutions holding stock - they're the ones that drive the price up. Is it a mining company? If so, this is super-typical, and not really a reason for concern in and of itself.

Obviously it depends on the company and the circumstances, but I consider it a good sign when management is savvy enough to recognize when it's wise to raise money for future growth. That's the point of being publicly listed. Not recognizing these opportunities can lead to cash crunches later on, and more dilution if you're forced into a bad deal. Feel free to memail me the company and I can take a general look this evening if you like.
posted by loquax at 7:23 AM on December 21, 2010

If so, this is super-typical, and not really a reason for concern in and of itself

It is also super typical of stock promote frauds.
posted by JPD at 7:31 AM on December 21, 2010

It is also super typical of stock promote frauds.

Unless we're talking about a pink sheet stock, or some other real bag of crap, I don't think the automatic reaction to a secondary equity raise should be that it's fraud. It might be a bad business decision. And regardless, regular promotes (that aren't frauds) are not necessarily bad in a bull market (especially in commodities, and especially if real institutions are buying in).
posted by loquax at 7:34 AM on December 21, 2010

I didn't say that the automatic reaction should be fraud. I said that this sort of behavior is also typical of frauds. It might not, actually probably isn't fraud (purely from a statistical perspective) , but at the the same time saying "this is super-typical, and not really a reason for concern in and of itself" is a bit too sanguine for my tastes.
posted by JPD at 8:02 AM on December 21, 2010

why not just tell us the ticker? there is a certain amount of "sniff test" required to really tell. a secondary by itself is not really good or bad - your shares are now worth a smaller percentage of the total equity, but the company got cash from the offering so in theory assuming the offering was reasonable and the company can deliver good ROI on the cash it received its a wash. 20% below the market seems fishy though.
posted by H. Roark at 10:05 AM on December 21, 2010

Response by poster: I think I've managed to get enough info from other sources to ease my anxiety of this morning, but I thank everyone who offered advice. 20% below market based on end of day price yesterday but really, because it surged so much in the last few days, they sold the stock at the same price as it was trading on Friday. So they got like $16 million in capital at a time when the stock was booming, a savvy move if I'm reading it correctly. Yes my piece of the pie is smaller but hopefully this is simply a move to raise some cash for a business that is growing quickly but steadily. I will continue to keep an eye on the stock and if there are more shenanigans I'll bail. So far, though, I'm happy with the performance of the stock and, like I said, I'm holding it long as I'm hoping for big things down the line. The ticker is KNDI.
posted by (Arsenio) Hall and (Warren) Oates at 10:12 AM on December 21, 2010

Now that you mentioned the ticker, you're right, $5.50 is only a slight discount to the 20 day moving average, which is what most deals are priced around. Also keep in mind that the company issued 3 year warrants for up to 1.2m additional shares, which is additionally dilutive beyond the 3m common shares, not atypical for small growth stocks. With a $6.30 exercise price, you'd likely be happy with that additional dilution.

I have no particular comment on this company - it could be a smart move, or it could be a cash grab. You'd have to do more research to figure that out (no brokers currently cover the company). Absent other information, not having a clearly defined use of proceeds while having a bit of a messy balance sheet would give me a bit of pause, along with the generally lower oversight of Chinese companies.
posted by loquax at 12:04 PM on December 21, 2010

Have you considered calling the investor relations firm that handles KNDI?
posted by josher71 at 12:10 PM on December 21, 2010

good luck with it - these chinese companies are very opaque. There is a bit of a problem going around lately where chinese companies, listed on nyse etc, are just scams. Its contracting multiples across the board. Im not trying to pick on this stock in particular, but if there were two chinese companies and 1 raised capital through a bank loan and the other sold stock I'd put my money into the one where the bank, with most likely more due diligence, was able to have enough confidence to establish a line of credit.
posted by H. Roark at 12:11 PM on December 21, 2010 [1 favorite]

Response by poster: Have you considered calling the investor relations firm that handles KNDI?

How do I figure out what the investor relations firm is that handles KNDI?
posted by (Arsenio) Hall and (Warren) Oates at 1:30 PM on December 21, 2010

IR for KNDI
posted by loquax at 1:34 PM on December 21, 2010

I go to Yahoo Finance and look at the press releases. Usually they are listed as a contact.
posted by josher71 at 1:34 PM on December 21, 2010

IR however, won't be able to give you much more than what's in the company presentations (if any, on the website) or in the filings (available on EDGAR), especially as you are a small retail investor and they are typically set up to get the company in the face of institutions.
posted by loquax at 1:36 PM on December 21, 2010

Response by poster: Ah, thanks. I typically go to Google finance - I see now the link to investor relations. Anything I should ask if I call tomorrow? Hey who are the investors? What are they planning on using the capital for?
posted by (Arsenio) Hall and (Warren) Oates at 1:38 PM on December 21, 2010

Response by poster: So probably not worth my time. I know that woman's name from previous press releases - she was holding conferences for investors back in November. And how dare you call me small time. I have literally hundreds of shares of their stock! ;)
posted by (Arsenio) Hall and (Warren) Oates at 1:39 PM on December 21, 2010

It is probably worth your time, actually. While IR is set up to get them in the face of institutions they most definitely take questions and elaborate for retail shareholders. Five year IR agency vet here.
posted by josher71 at 1:45 PM on December 21, 2010

From the prospectus for the offering (pretty pat):

USE OF PROCEEDS

We estimate that the net proceeds we will receive from this offering will be approximately $15,462,747, after deducting estimated offering expenses of approximately $1,187,249. We will not receive any proceeds from the sale of common stock issuable upon exercise of the Warrants that we are offering unless and until such Warrants are exercised. If the Warrants are fully exercised for cash, we will receive additional proceeds of approximately $7,628,745.60.

We intend to use the net proceeds from this offering for general corporate purposes and working capital, including for research and development, general and administrative expenses, and potential ordinary course acquisitions of technologies that complement our business. In the purchase agreement we have entered into with the purchasers in this offering, we have specifically agreed not to use the proceeds of this offering to satisfy any existing debt (other than ordinary course trade payables), to redeem any of our outstanding securities or to settle any outstanding litigation.

We have not specifically identified the precise amounts we will spend on each of these areas or the timing of these expenditures. The amounts actually expended for each purpose may vary significantly depending upon numerous factors, including assessments of potential market opportunities and competitive developments. In addition, expenditures may also depend on the establishment of new collaborative arrangements with other companies, the availability of other financing, and other factors. Subject to any agreed upon contractual restrictions under the terms of the purchase agreement, our management will have some discretion in the application of the net proceeds from this offering. Our stockholders may not agree with the manner in which our management chooses to allocated and spend the net proceeds. Moreover, our management may use the net proceeds for purposes that may not result in our being profitable or increase our market value.

Not sure what IR will be able to elaborate on beyond that but definitely worth a try (I didn't mean to step on any IR toes here, and I only have experience with it from the institutional side!). They won't tell you who bought on the deal unless it's publicly disclosed, and there don't appear to be any 5%+ holders currently.

You could ask how they plan to diversify the business (80%+ of sales from two customers), and to clarify what the company strategy is with respect to the significant debt it's carrying. You could ask what the expected headcount will be a year out, are they planning on investing in sales, new geographic markets, new end customer markets. Is management looking at any potential acquisitions? Is there a type of acquisition that could make sense in the context of management's strategy? Asking about rationale and the timing of the raise might elicit some interesting comments - is there something vague in the pipe? Was it just good timing? Was there strong institutional demand? Is there research coverage coming from the bank that led the deal? Does having more cash on the balance sheet help with customers/suppliers?
posted by loquax at 2:05 PM on December 21, 2010

I'm sorry, I was wrong, something called ExcelVantage Group LTD owns ~50% of the co prior to the deal. This appears to be a holding company controlled by the president of KNDI. You could ask IR if this company has maintained its proportional ownership of the company. Other than that, about 3% of the co prior to the deal was owned by institutions/mutual funds, and about 6% controlled by other insiders (management, etc).
posted by loquax at 2:13 PM on December 21, 2010

No toes stepped! These are all excellent questions from Loquax, (Arsenio) Hall and (Warren) Oates. I think worst case scenario they don't know the answers you're looking for and best case they can elaborate quite well on strategies and reasonings. Really depends on the IR person.
posted by josher71 at 2:19 PM on December 21, 2010

Ask if the institutions are locked up. If they aren't that's a point in the "mgmt stealing money" column. Assuming the deal closes by Jan 1 you should check the holders list after 2/15. If you don't see the new shares added to the register (and hopefully - new holders) be skeptical as well.
posted by JPD at 5:38 AM on December 22, 2010

Response by poster: Thanks for all the advice, everyone. I spent most of yesterday researching this company (and other Chinese companies in the same sector), the traders pumping the stock, and got some good perspective on some things. All in all, I learned a lot (not nearly enough, obviously), so thanks.
posted by (Arsenio) Hall and (Warren) Oates at 6:12 AM on December 22, 2010