All,
Been a reader for awhile--great website. I've got a technical question that I have been curious on. Let me know where my logic strays.
Why is market capitalization shares outstanding multiplied by share price, and not shares authorized multiplied by share price?
For example, let's say a company is looking to go public with 100 authorized shares. In the IPO, 49 shares are actually issued--say at $10. The company, I believe, is 49% public. The market cap, or equity value of the company, is $490. Wouldn't the remaining shares be considered equity--or at least potential equity--and therefore be considered the the market cap? Intuitively, it seems the market cap should be $1000.
I have a hunch this ties to equity dilution, but clearly am a little fuzzy. Let me know if you would like clarification.
Thanks.
Your hunch is exactly right. One thing you said that is not correct is that if 49 shares are issued, the company is "49% public". The issued shares are what matter - the 100 is just the total number that could eventually be issued at some unspecified time.
In your example, the entire company is "worth" (has a market cap of) $490. This is all of the shares that are outstanding x the share price.
Finance theory says that if you issued more shares, diluting each existing owner, the stock price would drop and market cap would remain the same (all else equal). For example, imagine you give 1 share away to the CEO as an RSU or bonus. Now there are 50 outstanding shares instead of 49. Theoretically, the price per share in the market would drop by ~2% to keep the market cap the same $490 (the company isn't worth anything different on an aggregate basis just because the CEO received a share).
That's very helpful. Thanks.
So, to clarify, if this company issuing 49 shares, it is 100% public, but only 49% of shares are currently available on an exchange? I think that was your point.
Hypothetically, if only one share were issued at IPO (instead of the previous 49), it would have been issued at $490 per finance theory--correct? That sure leaves a lot of dilution risk to the equity investor that holds that one share. In a 48-share secondary offering, the pro forma market cap would be $490(?), but if the investor elected not to purchase any additional shares, their formerly $490 valued stake is now worth $10. Is this sound theory?
Furthermore, if a market cap remains unchanged after follow-on offerings, how can a company even raise additional equity capital? Wouldn't that just be a net net scenario?
If we're able to get some answers here, I hope this thread proves useful to others. I Googled intensely for this type of info but couldn't find anything overly useful.
Market cap includes cash. Cash on the balance sheet increases, thus market cap increases.
Market cap does not include cash.
You're right, the company won't be able to increase their equity simply by issuing more shares. However, they will still receive cash from the issuance. Investors will pay cash to buy the stock and the company receives cash in exchange for giving up equity. The other guy's share values will drop, but isn't the company's direct problem; although in reality this goes into consideration in follow-up offerings. That's why you don't see follow-on offerings as often - it pisses off investors and potentially causes a sell off.
The only way to increase aggregate equity value is through earnings (i.e. company's operating performance). Think about it, if a company can increase equity value through issuing more shares, why don't they just simply do this forever and become the most valuable company ever?
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