I understand that you are in a way diluting current shareholders when you raise additional equity (assuming company is already public) because you now have lower eps and you have cut the pie into more pieces. My question relates to how the capital raised plays into this equation, as I feel like when people talk about dilution they brush over the cash the company just raised. Thanks in advance.
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Cash goes to the balance sheet so if you were just to raise Equity to sit on some cash it'd be the most dilutive because that cash isn't used to generate any earnings (more cash doesn't mean net earnings goes up). and just make things more clear, eps is price per share/earnings per share which is equivalent to market cap / net income. So in this case, your market cap went up but your net income stayed the same
EPS is earnings per share = Net Income/#Shares outstanding
http://www.investopedia.com/terms/d/dilution.asp#axzz2EDHz2VEl
and here's a definition of dilution if that's unclear
Thanks for the response. One of my original questions/points was that I feel that the new cash on their balance sheets adds value as it can be used to purchase assets and increase earnings. Also, theoretically should the stock price adjust so that market cap remains unchanged? Or does market cap increase as E=A-L, and assets and thus equity rises by the cash raised.
Edit: I think I get it now. You are simple reorganizing the capital structure. Equity value rises, cash rises, thus lowing net debt by the amount of the rise in equity value, leaving enterprise value unchanged. And as you pointed out same earnings over more shares=dilution.
You got it. Mkt cap rises, net debt goes down (as cash goes up), thus firm value doesn't change.
Sorry, meant to say pe ratio
You have the right idea. Most of the time when a company does an equity deal the use of proceeds will be 'general corporate purposes' so its inherently dilutive because you can't make a far stretched assumption that the new cash will be used efficiently to boost earnings. However, in some instances where there is a clearly defined UOP (ie an acquisition), the company selling equity will try to illustrate how the raise will be used to fund a transaction that will be accretive down the road.
Ok, so it seems like there is a bit of a contradiction in the case in which a company doesn't detail how an equity raise will boost earnings. It seems as though on one extreme earnings forecasts remain unchanged, thus EPS diminishes, thus share price should come down so that market cap is the same as it was before the issuance (in theory, this would leave mkt cap unchanged, lower net debt, and lower firm value). The flip side is that the company issues shares at the pre-issuance market price and the share price doesn't fall which raises mkt cap and lowers net debt by the amount raised, leaving firm value unchanged. Is the reality usually somewhere in between, where the cash is given some discounted value, so share price falls but mkt cap still rises (but by less than the proceeds of the issuance)? Also, as a shareholder is there a situation in which an equity raise will potentially be viewed as a positive apart from an accretive acquisition opportunity or an issuance at a premium to NAV/share. Lastly, what is a situation in which an accretive acquisition is not viewed favorably (I've read that the accretion/dilution of a transaction doesn't tell the whole story)? Thanks!
my 2 cents:
1) "It seems as though on one extreme earnings forecasts remain unchanged, thus EPS diminishes, thus share price should come down so that market cap is the same as it was before the issuance (in theory, this would leave mkt cap unchanged, lower net debt, and lower firm value)"
This analysis is flawed: while EPS does diminish share price does not necessarily go down, unless you're under the assumption that p/e is constant which has no basis. In theory what happens is your mkt cap goes up net debt goes down by the same amount and firm value unchanged. Why would the firm value change if you're just putting cash (even if it's just sitting there) on a firm's balance sheet?
In reality though followons are almost always at a discount due to many reasons and has been a major topic in academia. Just google it and you'll find plenty of explanations.
2) "Also, as a shareholder is there a situation in which an equity raise will potentially be viewed as a positive apart from an Accretive acquisition opportunity or an issuance at a premium to NAV/share"
If the UOP is for sth really profitable and NPV positive then in theory it can be viewed as positive. In reality if there's was such an opp then market woulda priced it in b4 the raising already.
3) "Lastly, what is a situation in which an Accretive acquisition is not viewed favorably (I've read that the accretion/dilution of a transaction doesn't tell the whole story)?"
If the target's earnings is projected to be flat until the end of time (a bit extreme but you get the idea)
bump
DB - raising equity would be dilutive - do you get it? (Originally Posted: 10/03/2016)
Extract from the FT about DB. "Another problem is that given the share price more than halved in the past year to a level 70 per cent below its book value, an equity issue would be prohibitively dilutive."
Could someone confirm that my understanding from the above statement is correct. Raising equity is dilutive by nature whether the share price has halved in recent months or not. You had a share and you were entitled to a piece of the company's profits. Now more people are entitled to this dividend and hence the dividend per share has decreased: you are less off.
Now if the share price has plunged recently, the existing shareholder will be worse off if a equity issuance happens now because the newly sold share prices will be sold at a very low price and leaving money on the table.
This is my intuition and what I could recoup from my corporate finance class but I feel I am missing something here, can someone give me another reason why raising equity at this time would be so bad?
Thanks
Someone else can correct me if I'm wrong, but I would think one scenario would be more dilutive than another. If one share becomes two shares, its 50% dilutive, in a sense. However, in DB's case, because the stock price is so low, it's going to take more shares being issued to achieve the same capital raise. More shares in the market = more dilution.
This is what I take away when reading this.
Typically, you'd want to raise a certain dollar amount and not necessarily target a # of shares issued. If you want to raise $1 Bn, he number of shares you have to issue = 1Bn/Price per Share. If your denominator was recently halved, you can guess what that means for number of shares required to be issued (and the resultant diluting effect).
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