What does it mean for a company to issue new stock?

Meryll Lynch will sell $8.5B in new stock. What does this mean for the existing ML shareholders? It means that new investors will be getting a piece of the company, but they'll be paying for it, which means old investors really are getting something in return for the stock dilution - cash. As an investor you only want this deal if your company needs a liquid cash shot in the arm, such that if it can't get it then your (undiluted) stock becomes worthless anyway.

The best deal for existing owners involves issuing the lowest number of shares at the highest price such that it's enough to save them. How do you determine these numbers? Seems to me that these numbers are largely a function of the current share price, outstanding stock count, and the estimated cash needed to solve the problem. And I have no idea what that function is.

The buyer wants the most shares at the lowest price, because in the event of a recovery the upside is much larger.

Another way to analyze the correct price for a new stock issue is to look at a hypothetical buyout. If the company recovers successfully, how much would ML be worth to a buyer (assuming 100% of sellers would be willing to sell at approx market rate)? (I believe this number is called "market capitalization".) Let's say that ML is worth $20B now but has every reason to believe it should be worth $100B, which it was 6mo ago (I'm totally making these numbers up). If there are 1B outstanding shares, should an investor think about buying at $20 or $100, or something else? Well, $100 makes no sense as there's no profit in it, even in the best case. $20 is a good number because their shares will be worth the same as everyone elses when they "hop on board" and stand to lose (or gain) exactly the same. However, $28.5 may make more sense: that's because if ML's value is $20B then gets $8.5B in cash, the company is, strictly speaking, worth $28.5B. So perhaps the new investors should spend $28.5/share!

So I guess assuming the sale goes well, it's actually a really really good thing for ML owners to get that cash - they see an immediate increase in stock value, and have the jet fuel needed to get past a rough spot and toward that $100B mark.

No comments: