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You're mixing cash on hand and equity and still ignoring dilution. I don't know where this term "neutral transaction" came from but it's not true on the balance

by tacos 12y ago

You're mixing cash on hand and equity and still ignoring dilution. I don't know where this term "neutral transaction" came from but it's not true on the balance sheet in the dividend case and it's not true in the market in the new issue or buyback case due to externalities. Consider: Shady Patents, Inc has 10 shares outstanding. Current price is $1/share. I own one share. They issue 90 more shares at $1/share. Yes, duh, shareholder's equity remains constant. Shareholder DILUTION however is substantial. If they collect $1 million on a patent and issue a special dividend, I'm getting $1,000 instead of $100,000. YES, there's an equal credit and debit on the balance sheet. NO, this does not mean the market will prop up the price. OF COURSE issuing shares is going to create downward share price pressure. If it didn't, companies would just issue shares indefinitely. And yes, to back up what poor OP said six hours ago, shareholders often resist dilution.

pedrocr 12y ago
> Yes, duh, shareholder's equity remains constant. Shareholder DILUTION however is substantial. If they collect $1 million on a patent and issue a special dividend, I'm getting $1,000 instead of $100,000. Clearly that payout was not priced into the original share price a the time of the capital raise so the new shareholders indeed got a great benefit at the expense of the old ones. At the moment of the transaction though the company went from being valued at 10$ to being valued at 100$ and for that to happen 90$ in cash was added to the company. The company could have turned around and used the same 90$ to buy back the same shares, which is why the transaction itself is neutral to shareholders. As the share price changes over time that may turn out to be a good or a bad idea.
- tacos 12y ago
  At the moment of the transaction the books said the company had $90 more. But this does not matter much because shares were issued. In your imagined impossibly-simple company where market cap always equals cash on hand you can ignore this. In the real world, where the Earnings Per Share suddenly dropped by a factor of 100, perhaps you can imagine what will happen to the share price.
  - pedrocr 12y ago
    > In your imagined impossibly-simple company where market cap always equals cash on hand you can ignore this. In the real world, where the Earnings Per Share suddenly dropped by a factor of 100, perhaps you can imagine what will happen to the share price. I never said market cap equals cash on hand, I'm talking about the normal valuation of the company. You have a company that is valued as a whole at 10$ by the market, not just cash, everything. You raise 90$ of capital by issuing 90 new shares, bringing the total up to 100 shares. That company is now worth the original 10$ plus the new 90$ that were put in. So it's worth 100$ in total and still 1$ per share. This is just the basic math of a capital raise or dividend/share buyback, there's no way around it.
    - tacos 12y ago
      You're confusing book value with market capitalization and shareholder's equity. In your magic company they're always identical. In the real world they never are. More germane to HN: I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie? C'mon dude, admit you're wrong and move on.
      - pedrocr 12y ago
        > You're confusing book value with market capitalization and shareholder's equity. In your magic company they're always identical. In the real world they never are. No I'm not. I've always referred to market cap, never accounting. > I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie? At the moment of the transaction yes, it's neutral. You could use the money you just raised to buy back the shares you just issued and be back to square one. That's all I am saying and it's a basic point taught in finance classes. In fact if what you suggest happened, and the share value tanked you'd have a perpetual money making machine. Just raise a bunch of capital, watch your stock tank, buy back shares and end up owning the whole company again plus some left over cash. That doesn't mean that raising capital can't in the long term add or destroy value in a company, it's just not the transaction that does it, it's what you do or don't do with the money. If you use the money so that the total employed capital has a higher rate of return than just the original one, the value goes up, if not it goes down.
ghshephard 12y ago
So, let me pay close attention to you, to see if I can understand the message you're trying to communicate here, as I think there are a number of elements at play. First, I think your example of dilution and it's impact on returns is a good one. Dilution - a nice neutral definition can be found here: http://www.investopedia.com/terms/d/dilution.asp http://www.investopedia.com/terms/d/dilution.asp A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur when holders of stock options (such as company employees) or holders of other optionable securities exercise their options. When the number of shares outstanding increases, each existing stockholder will own a smaller, or diluted, percentage of the company, making each share less valuable. Dilution also reduces the value of existing shares by reducing the stock's earnings per share. I sense we were overly focussed on the impact to the balance sheet, and ignoring the impact on share of earnings, so I will grant you that Dilution's impact on EPS (and, eventually share of dividends), is a reason that shareholders might resist Dilution.) But, I think it's important to recognize a couple things. First, issuing shares does not always create downward share price pressure. It's quite often the case (particularly in startups), that an infusion of cash has a significant upwards impact, as the liquidity may now make the company much more valuable. Another good example might be Apple, back in 1997. Microsoft's $150 million got 150,000 shares of stock. That liquidity injection (at a pre-split price of $2.50) gave Apple an important boost at an important time - that I would argue created upward share price pressure. On the flip side - http://www.investopedia.com/articles/stocks/11/dangers-of-stock-dilution.asp http://www.investopedia.com/articles/stocks/11/dangers-of-st... has a nice writeup on how to deal with issues surrounding dilution.
- tacos 12y ago
  pedrocr jumped all over this post for some reason and took it in a very, very weird direction. I'm amazed that a discussion on HN involves people talking about how issuing shares is a neutral, zero sum event for shareholders (AKA founders). Specific to the MSFT/Apple deal you mention -- and more notably as part of Warren Buffett's deals with GS/BofA/GE -- those were preferred and non-voting shares. So there was no dilution in either EPS or voting control. Microsoft re-assuring that it would continue to produce Office for Mac affected the price. Apple taking out what was effectively a $150 million loan at 6% interest was not the source of the excitement. Buffett's deals also included warrants. I can no longer devote time to being the thread savior here but I'd encourage anyone reading this to walk through those deals and think through the implications. It's pretty interesting stuff.

by tacos 12y ago

pedrocr 12y ago

> Yes, duh, shareholder's equity remains constant. Shareholder DILUTION however is substantial. If they collect $1 million on a patent and issue a special dividend, I'm getting $1,000 instead of $100,000. Clearly that payout was not priced into the original share price a the time of the capital raise so the new shareholders indeed got a great benefit at the expense of the old ones. At the moment of the transaction though the company went from being valued at 10$ to being valued at 100$ and for that to happen 90$ in cash was added to the company. The company could have turned around and used the same 90$ to buy back the same shares, which is why the transaction itself is neutral to shareholders. As the share price changes over time that may turn out to be a good or a bad idea.

tacos 12y ago
At the moment of the transaction the books said the company had $90 more. But this does not matter much because shares were issued. In your imagined impossibly-simple company where market cap always equals cash on hand you can ignore this. In the real world, where the Earnings Per Share suddenly dropped by a factor of 100, perhaps you can imagine what will happen to the share price.
- pedrocr 12y ago
  > In your imagined impossibly-simple company where market cap always equals cash on hand you can ignore this. In the real world, where the Earnings Per Share suddenly dropped by a factor of 100, perhaps you can imagine what will happen to the share price. I never said market cap equals cash on hand, I'm talking about the normal valuation of the company. You have a company that is valued as a whole at 10$ by the market, not just cash, everything. You raise 90$ of capital by issuing 90 new shares, bringing the total up to 100 shares. That company is now worth the original 10$ plus the new 90$ that were put in. So it's worth 100$ in total and still 1$ per share. This is just the basic math of a capital raise or dividend/share buyback, there's no way around it.
  - tacos 12y ago
    You're confusing book value with market capitalization and shareholder's equity. In your magic company they're always identical. In the real world they never are. More germane to HN: I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie? C'mon dude, admit you're wrong and move on.
    - pedrocr 12y ago
      > You're confusing book value with market capitalization and shareholder's equity. In your magic company they're always identical. In the real world they never are. No I'm not. I've always referred to market cap, never accounting. > I'm a founder. I own 50.01% of my company. Issuing stock is a "neutral" event for me because I'm going to own a smaller piece of a bigger pie? At the moment of the transaction yes, it's neutral. You could use the money you just raised to buy back the shares you just issued and be back to square one. That's all I am saying and it's a basic point taught in finance classes. In fact if what you suggest happened, and the share value tanked you'd have a perpetual money making machine. Just raise a bunch of capital, watch your stock tank, buy back shares and end up owning the whole company again plus some left over cash. That doesn't mean that raising capital can't in the long term add or destroy value in a company, it's just not the transaction that does it, it's what you do or don't do with the money. If you use the money so that the total employed capital has a higher rate of return than just the original one, the value goes up, if not it goes down.

ghshephard 12y ago

So, let me pay close attention to you, to see if I can understand the message you're trying to communicate here, as I think there are a number of elements at play. First, I think your example of dilution and it's impact on returns is a good one. Dilution - a nice neutral definition can be found here: http://www.investopedia.com/terms/d/dilution.asp http://www.investopedia.com/terms/d/dilution.asp A reduction in the ownership percentage of a share of stock caused by the issuance of new stock. Dilution can also occur when holders of stock options (such as company employees) or holders of other optionable securities exercise their options. When the number of shares outstanding increases, each existing stockholder will own a smaller, or diluted, percentage of the company, making each share less valuable. Dilution also reduces the value of existing shares by reducing the stock's earnings per share. I sense we were overly focussed on the impact to the balance sheet, and ignoring the impact on share of earnings, so I will grant you that Dilution's impact on EPS (and, eventually share of dividends), is a reason that shareholders might resist Dilution.) But, I think it's important to recognize a couple things. First, issuing shares does not always create downward share price pressure. It's quite often the case (particularly in startups), that an infusion of cash has a significant upwards impact, as the liquidity may now make the company much more valuable. Another good example might be Apple, back in 1997. Microsoft's $150 million got 150,000 shares of stock. That liquidity injection (at a pre-split price of $2.50) gave Apple an important boost at an important time - that I would argue created upward share price pressure. On the flip side - http://www.investopedia.com/articles/stocks/11/dangers-of-stock-dilution.asp http://www.investopedia.com/articles/stocks/11/dangers-of-st... has a nice writeup on how to deal with issues surrounding dilution.

tacos 12y ago
pedrocr jumped all over this post for some reason and took it in a very, very weird direction. I'm amazed that a discussion on HN involves people talking about how issuing shares is a neutral, zero sum event for shareholders (AKA founders). Specific to the MSFT/Apple deal you mention -- and more notably as part of Warren Buffett's deals with GS/BofA/GE -- those were preferred and non-voting shares. So there was no dilution in either EPS or voting control. Microsoft re-assuring that it would continue to produce Office for Mac affected the price. Apple taking out what was effectively a $150 million loan at 6% interest was not the source of the excitement. Buffett's deals also included warrants. I can no longer devote time to being the thread savior here but I'd encourage anyone reading this to walk through those deals and think through the implications. It's pretty interesting stuff.