Well, Thursday morning blessed us with a look at one of the freight trains I referenced the other day, this one in the form of a secondary offering from Village Farms (VFF) . I did see some guesses on Twitter earlier this week as to that being the potential cause. Then again, I saw many other wild guesses. Again, we don't know until we know. And now, we know.
I'm not disappointed in the fact Village Farms is raising money. I'm disappointed in how this transpired. Management waiting until an absolute low point in the market with their stock breaking down to make a move. This signals either they had no other choice or they aren't reading the market well. Neither is a good thing. The company had more than half of September to snag prices 40% to 60% higher than where this offering is being sold.
Furthermore, there is no clarity as to the offering yet. If this is because their Pure Sunfarms partner is having an issue funding its other half of the partnership (Emerald Health (EMHTF) , not Village Farms), then find a way to say so. The market will assume the worst-case scenario in the short-term without additional information. This could be a good move long-term, but traders don't know what they don't know.
Worst of all, there is either a leak inside Village Farms in regards to the offering (I don't believe this is the case) or the underwriters turned the screws on this deal to achieve maximum profits for either themselves or some preferred clients.
It's fun to play out an offering scenario, though, to get a better understanding of what happens behind the scenes. There are two ways this can play out: management initiates or underwriter initiates.
Let's examine a "management initiated" scenario.
Please note, this is a fun, fictional portrayal of how an offering might play out for a company.
Beginning of October
Management, sitting around a large oak table with many rich, mahogany bound books on the shelves: "Markets been rough and we're down pretty hard today, but there's an opportunity if we had some extra cash."
Two Days Later (Oct. 3)
Management staring at stock action: "Nice bounce off the bottom. I think there's enough confidence to take the call--"
Phone rings before management even has a chance to finish their sentence. The underwriter is on the line.
"Did someone say offering?"
The two begin feverishly putting together the details.
Management says, "We only need $10 million."
The underwriter purrs, "But $50 million is no problem especially on a best-efforts arrangement."
"Fifty would kill our shareholders," management says. "And we need a bought offering."
"I see. Then, we better drop it to twenty," the underwriter proposes.
"Wait, you just said fifty." Management coffers in the corner. "How about thirty?"
"Twenty-five max, if this is a bought deal." Diamonds light the corner of the underwriter's eyes.
A pensive rub of the chin and the two sides shake hands.
Now, the bought deal means that even if the underwriters have to buy the shares themselves, the deal will get done. It is better for the company and more risk for the underwriter; therefore, the underwriter will often drive a tough bargain, like pricing the offering 11% below the closing price. On a best-efforts, the underwriter sells what they can sell and the offering company lives with the net proceeds, whatever they may be.
Once the deal is agreed upon, the underwriter gets to work forming a syndicate in some cases or simply gathering those clients it believes will buy the shares. Unfortunately for shareholders, this is where the freight train comes into play.
Oct. 8 & 9
The underwriter stands among a bank of computers, "Short every last share you can find!"
The underwriter knows it may be buying shares, so we start to see selling on the market. In this case, it may have begun on Oct. 7 or it could have waited until the 8th, but the wink-wink, nod-nod action behind the scenes is the eventual buyer is either selling shares out of inventory or shorting shares knowing the offering will give it a chance to deliver (repay its short share borrow) at a lower price.
It is the ultimate arbitrage. Of course, there is no guarantee the stock will move lower into the offering, but it is rare to see one, especially a smaller stock, move up into the offering. This is a great way for an underwriter to pad their already generous commissions or pass along a high-reward, "low" risk trade to its eventual buyers.
Once again, this is all a fictional portrayal. And we can shout all we want about potential scenarios like this or we can face the reality of what really happens behind the scenes to understand why a stock may behave the way it does.
Unfortunately, I'm an owner of VFF, rebuying recently, but no less painfully. However, if management doesn't clarify and rectify what transpired on Thursday, the stock will be short on time in my portfolio world for the foreseeable future.
Sometimes you have to be blunt and this is me being blunt. VFF management must do better.