Friday, March 20, 2009

IPOs And Secondaries, A close look

Two things have been happening a lot lately, IPO’s and “secondaries” and since we’ve got a lot of new people reading the publication I thought I might want to visit secondaries for a moment. Most people understand the idea of an IPO, but a secondary often gets them a bit confused.

A secondary offering occurs when a company literally releases more stock out into the float. But some interesting things usually take place when that happens. Let's look: In general terms when a secondary is announced the stock will fall like a rock for a day or so. Why? Well, basically they are saying, "We are putting more shares out there" and that has the undesirable effect of "dilution." So more times than not when a secondary is announced, that stock takes a tumble.

Now, why do they do secondaries? For a number of reasons. First, they want money. The money is generally slated for some type of expansion project or even hopes of an acquisition. Then they also do them to put more shares out for institutions to buy. Some institutional buyers will actually approach management and say, "Hey we would like to take a stake in you but you don't have enough shares for our liking." Many companies want the exposure that institutional buying brings and will do the secondary. Sometimes it is done to allow insiders a chance to sell their shares too. (That isn't too widely done but it happens) So what does all this mean for us? It means that there is a good chance the stock will take a near term hit. BUT it also means the stock will probably be a good buy again shortly afterwards. Here is why: When a secondary is to be done, there are underwriters involved in marketing that stock just like when the stock first came public.

Those underwriters are going to want to see the stock price move higher after the offering (so they can make some money) and will put on a "road show." That just means they will hype the stock trying to get buyers attracted to it and get the price moving up again. The moral of the story is that when a good solid company that is growing does a secondary offering, we can often get the chance to get into that company at a reduced price. The rebound in the share price can often be dramatic, often running well past the price when the secondary was announced.

Many times big buyers from institutions are waiting in the wings for the effects of the secondary to drive the stock's price down so they can get in it. All that buying, along with the underwriters "road show" can rebound those shares quickly. So, when you hear a company announce they are doing a secondary offering, look for the expected sell off, but watch that stock closely right after it actually executes the sales. Chances are good that in a short period of time they will be moving higher!

PS. We only like to see secondaries in "decent companies." A no name company that trades no volume is not a good candidate.

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