Equity Issuance Vs. Equity Retirement

Equity Issuance Vs. Equity Retirement

Author: Joris Kersten MSc

Kersten Corporate Finance: M&A Advisory + Business Valuations @ The Netherlands.

Training: Business Valuation & Deal Structuring, 5 day training, 4th – 8th November @ Amsterdam South (Zuidas).

Source used: Morgan Stanley Investment Management, Counterpoint global insights. Which one is it? Equity issuance and retirement. July 2024. Michael J. Mauboussin & Dan Callahan.

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Introduction

Companies issue and retire equity.

The main reasons to issue equity are to:

·???????? Finance Mergers & Acquisitions (M&As);

·???????? Compensate employees;

·???????? Fund operations;

·???????? Change the capital structure (the mix of debt & equity).

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And retiring equity returns capital to the selling shareholders.

Moreover, this can have further benefits like:

·???????? Signalling the shares are undervalued;

·???????? Reducing the risk of mis-allocating cash (putting it in NON-positive net present value projects);

·???????? Increasing earnings per share (EPS “accretion”);

·???????? Offsetting “dilution” from SBC (stock based compensation).

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Equity issuance

When we look at equity issuance for all companies with stocks listed on the major exchanges in the US from 2000 to 2023, we see certain patters.

Over this period, equity issuance was close to 10 trillion USD.

And further divided:

·???????? Equity financed M&As were 58% of the total;

·???????? Stock based compensation (SBC) was 22% of the total;

·???????? Seasoned equity offerings (SEOs) were 20% of the total.

SEOs are basically shares issued to investors, other than IPOs (initial public offerings).

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Mergers & Acquisitions (M&As)

In 25 years ending in 2023 most M&As were funded with cash.

But still enough deals were financed with equity which leads to M&As being the largest category in equity issuance.

M&A deals financed with equity realise that buyers can:

·???????? Persevere cash;

·???????? Avoid debt;

·???????? Do deals larger than their “debt capacity” would allow;

·???????? Create an interesting tax environment for the sellers (deferring tax liabilities).

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Stock based compensation (SBC)

SBC as a percentage of sales for companies in the Russell 3000 went up from 0.2 % of sales in 2006 to 1.3 % of sales in 2023.

(The Russell 3000 is an index that measures the performance of roughly 3000 US stocks)

And the dollar sum rose from 26 billion USD in 2006 to 290 billion USD in 2023.

There are a few reasons for this:

·???????? Shift in the mix of companies towards those who like SBC (e.g. technology companies);

·???????? The institutional imperative (companies imitate each other);

·???????? Competition in the labour market;

·???????? Lower cash payments filled in with SBC;

·???????? Rising CEO payment with SBC being responsibly for the rise for a large part;

·???????? Perceived benefits of “incentivizing” and “retaining” employees by SBC.

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Seasoned equity offerings (SEOs)

Consistent with the finding that companies are good at buying low and selling high, research shows that companies that undertake SEOs have sub-par stock returns, on average, following such a deal.

But it is more complex than this, because the motivation for the SEO is also important.

There are 3 possible motivations for an SEO:

·???????? To recapitalise the balance sheet (increasing ratio of equity to debt);

·???????? To fund an investment;

·???????? For a “general corporate purpose”.

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And here research found that stocks issued for “recapitalisation”, or for “general corporate purpose”, have underperforming underlying stocks, compared to the market.

And this is NOT the case for companies that undertake an SEO to fund a specific investment!

Moreover, it is also important who buys the SEO.

SEOs with “large institutional allocations” outperform those without those allocations.

Since these parties know their due diligence!

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Companies retiring equity

US public companies retired 14 trillion USD of equity during 2000 to 2023.

So in the end there is a “net retirement of equity” because:

·???????? Small companies tend to issue equity;

·???????? Large companies generally retire equity.

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In this century US public companies have funded their growth largely with “cash from operations”.

And also there was a small contribution from an increase in debt.

And many companies decided to buyback/ retire stock because:

·???????? They have excess cash;

·???????? They want to offset “dilution” from SBC;

·???????? They seek to boost EPS ( “EPS accretion” ).

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Summarised, from 2000 to 2023 public companies in the US issued nearly 10 trillion USD in Equity. And they retired about 14 trillion USD in equity.

Most of the equity was used for M&As, followed by SBC and SEOs.

And equity was retired to “signal” that their stock was under-valued, and to offset “dilution” from SBC!

Overall, smaller companies realise “dilution” of shares (more shares), and the ongoing shareholders of larger companies increase their ownership (less shares).

This last phenomenon realises the “net retirement of equity” during 2000 – 2023!

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Hope this was useful, see you next week again with a new blog !

Best, Joris Kersten,

from Kersten Corporate Finance.

Source used: Morgan Stanley Investment Management, Counterpoint global insights. Which one is it? Equity issuance and retirement. July 2024. Michael J. Mauboussin & Dan Callahan.