The Necessary Evil (and Benefits) of Raising Capital

Running major companies presents many types of challenges. Shareholders are always clamoring for share buybacks, dividend payments or increases and anything else they feel will increase their stocks' prices. When times are good and cash flow is abundant, those actions can be readily undertaken. Shrinking a company's outstanding shares raises earnings per share by splitting total profits by a smaller number. Buying back stock at above book value, however, is always dilutive, lowering book value for all remaining shares. Paying out dividends, or increasing existing rates, takes away flexibility from management regarding internally financed future growth. As with pretty much everything in life, nothing is either all good or all bad. Not all years go smoothly. Unexpected business conditions, like those in 2020, often throw monkey wrenches into even the best laid plans. Giving shareholders what they want can become impossible. In fact, trying times can make for hard choices if new capital is required to ride out bad times. Publicly traded firms can raise capital by selling new shares via secondary offerings. They can also increase cash via sales of bonds or preferred shares. The following examples of how a several companies navigated this tumultuous year might help you understand the pros, cons and necessities of why they took the actions that occurred. High-end mall operator Simon Property Group faced tremendous pressure when forced to temporarily close all its malls due to Covid-19. Superimposed on that was their pre-Covid decision to purchase 80% of industry rival Taubman Centers . SPG's cash flow was seriously dented by the retail shutdown. Management trimmed the quarterly dividend, unilaterally cancelled their deal to buy TCO and hunkered down to ride out the pandemic. Share buybacks, in place since 2016, were suspended. TCO sued SPG trying to force the deal to go through. A recent settlement between the parties seems like a win/win situation. SPG will go ahead with the transaction, but at a discounted price vs. the original offer. Rather than borrow to close this purchase, SPG issued 19.25 million new shares at $72.50 each, with an underwriters' 2.9 million share over-allotment option for more. Selling shares at that price will be very accretive to book value which was previously expected to be just $7.50 or so by Dec. 31. SPG will become bigger and more dominant in the one segment of retail malls, which appears to be thriving. The market likes both this transaction and way SPG funded it. As of Thursday at 1:40 p.m., SPG was trading up more than 5% on the day. Two of the three major cruise companies tapped the public markets by issuing new shares this week, in the wake of positive Covid vaccine news. NCLH was initially lower after pricing 40 million newly issued shares at $20.80. With negative revenues since being forced to stop operating last March, this industry is on the ropes. Revenue is negative due to refund requests from people who had already paid for cruises that never happened. Management had been buying back shares regularly since 2015 as pre-Covid profits soared. Now, with huge losses and plenty of debt, the move to increase the share count was really the only way to fund deficits until cruising can begin again. Equity holders don't need to be paid back like bond holders and there is no increase in debt service expense due to the higher share count. Making this secondary offering was a necessary evil of try to survive. One bright spot. The recent share price bounce allowed the new shares to be issued above today's book value, actually raising it in the short run. Carnival Corp. was in pretty much the same boat, pardon the pun, as NCLH. Its equity raise was necessary, despite being dilutive to book value. CCL will use some of the proceeds to retire convertible preferred shares with a 5.75% interest rate, due in 2023. Converting debt to equity removes interest expense as well as taking away the balloon payment of principal that would have been due a few years out. As with NCLH, the initial market reaction was to push CCL lower. A few hours later, CCL joined NCLH at a higher level. Informed investors know that the equity issuance was needed if these companies intend to be alive for the next good cycle for cruising. Plug Power is yet another struggling firm that issued secondary shares this week. PLUG has never made a profit. In fact, from 2013 through 2019 it posted cumulative losses of almost $578 million. Losing money every year burns through a lot of cash. How has PLUG managed to avoid bankruptcy while blowing through huge losses? This week's was just one of a series of secondary issues. On Dec. 31, 2012 PLUG had just 38.24 million shares outstanding. As of Dec. 31, 2019 there were 303.38 million. Suckers, ahem, investors continue to hold onto hope that someday this firm will turn profitable. PLUG is the riskiest kind of stock. It can only continue operations by attracting new capital to fund its very substantial operating deficits. Give management credit, though, for taking advantage of the stock's recent run-up to issue shares while they're hot. Selling shares now will bolster book value, which was flirting with negative, will refilling the till. Not all capital raises are bad. Last April Apple tapped the bond market for $17 billion it really didn't need. The rates paid were so low that share buybacks became accretive to earnings per share and even, on the shorter duration paper, a savings vs. the dividend owed on the retired shares. Apple is so fiscally strong that increased debt and a reduction in book value are not worrisome. The Federal Reserve's ZIRP policies are making the rich, like AAPL, even richer. I hope this article helped clear up some principles regarding capital raises. Feel free to put any questions you might have in the comments box section. (AAPL is a holding in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells this stock? Learn more now.)

The Necessary Evil (and Benefits) of Raising Capital

Let's look at the pros, cons and necessities of why these companies raised capital and how they did it.

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