Article on banks James Kostohryz was formerly the head of international investments for a major Brazilian investment bank.
There's been quite a bit of discussion in financial markets about the slew of companies that are issuing shares (Bank of New York (BK), Morgan Stanley (MS) and Wells Fargo (WFC), for example). Many believe that this could be a sign of a top for the S&P 500 (SPX). The reason people think that this could be a sign of a top has to do with a point that Minyan Peter has often made: Companies issue equity only if they have to (i.e. they're in trouble) or if they'd be dumb not to (i.e. the companies share price is overvalued).
I certainly appreciate this point, and I think that under normal circumstances, such skepticism will prove prescient. I also appreciate the technical concerns about supply overhang.
However, under current circumstances, I have a different take.
We're in a situation where for systemic reasons, many companies are pricing in a high risk of insolvency. If the equity offerings increase companies’ capitalization and liquidity, and effectively eliminate this risk, then it's a win-win situation. Sure, companies suffer dilution when they issue shares. However, this dilution in many cases is far less than the discount the market has been placing on them for insolvency risk. If the cost of eliminating insolvency risk is a dilution of, say 30%, and this elimination of insolvency risk allows the value of your stock to rise by, say 100%, this is a very good deal for shareholders. This seems to be what's occurring now (witness Bank of America); it's why stocks that have successfully placed equity offerings are rallying.
There's another issue here that's even more fundamental. An equity issuance is bullish for shareholders if the NPV of the uses of the capital raised is greater than the cost of capital. In a world where there are assets of all sorts that are selling at distressed values in both public and private markets, companies with liquidity will be able to acquire earning assets at fire-sale prices. Such acquisitions will be accretive to earnings in the long term. So for companies making equity offerings, it’s a matter of being well capitalized and liquid so as to allow them to take advantage of extraordinary opportunities. It's a matter of short-term dilution versus long-term accretion.
I'll make one final point. Enabling companies to raise capital is the whole reason that capital markets exist. (Sorry guys, it's not so that you and I can day-trade stocks! That's simply a means to the ultimate end, which is to enable the raising of capital). It's a bit perverse to suggest that the fact that capital markets are fulfilling their purpose is a bearish sign. To the contrary, equity offerings are a clear sign that financial markets are healing - that they're functioning and fulfilling their purpose.
When you consider what we've just been through -- where it was absolutely impossible to raise money in private-capital markets -- recent developments, far from being bearish, are very bullish.
Indeed, equity offerings are one more sign -- a very important sign -- that the crisis is over. For now.
I would add that raising money for the worst case does not sit idle and gain no interest. |
