In a flat market like 2014 where stocks go side to side, it is nice to have a place where you can go to and get 4-5-6-even 7 % in a week’s time. Companies often raise capital via an new public offering of common shares. There are many ways of raising capital. Two common ways are as follows. The first, the company hires its underwriters and tells them they want to offer 5 million new shares on the market for 10$ per share, raising an extra 50 Million. The underwriters will then offer these new shares to their clients and sell these shares, behind closed doors. The company will then issue a press release stating that they have raised 50 M by offering new shares on the market. These types of deals are called “Pre Bought” new issuance of shares. In this market environment these types of offerings tend to “sell out” or better known as ” oversubscribe”. What is nice about these deals is the company always sells below what the stock is currently trading at. So for example, in order for the new issuance to be offered at 10$ as in our above example, the stock will be trading above 10.50$ sometimes as high as 12$. You can see how accretive it is to the people who participate in these offerings as they are already making a profit investment and/or bet.
The problem is unless your firm is of a certain size and you are able to commit, not only for this specific deal, but for any subsequent new issuance that comes out you will most likely not be getting a call from the underwriters (Goldman Sachs, JP Morgan, Credit Suisse, etc).
I like playing this special situation another way. Often, a company decides to announce they will be raising capital, but do not disclose the price of the offering. They usually disclose the price of the offering a few days later. When this happens, you stand a chance of making 4-8% in a relatively short period of time due to uneconomic selling. Readers must understand and be cautioned that this is a bet, and when you make a bet you must calculate what are the odds of you winning and losing. These bets are not long-term investments so you should not wait and hold. The advantage of these bets is that you know if you are right or wrong within a few days, sometimes a few weeks.
Let us look at an example of a new issuance of shares, Orbitz Worldwide (OWW). Orbitz is a competitor to Expedia. Members can book plane tickets and hotels on their website. They have been restructuring the past few years and have started a new imitative with Orbucks that management is really banking on.
Since the beginning of May 2014, Orbitz was steadily trading between 7.1$ and 7.5$. On May 19th, something happened, the stock dropped below 7$, as low as 6.6$ on May 20, 21 and 22. No financial data or anything regarding the business was reported so the business was operating as usual. On May 19, the company issued the following press release:
Orbitz Worldwide Announces Secondary Common Stock Offering by Selling Stockholder
CHICAGO, May 19, 2014 (GLOBE NEWSWIRE) — Orbitz Worldwide, Inc. (NYSE:OWW) today announced an underwritten public offering of 7.5 million shares of its common stock by an affiliate of Travelport Limited (the “Selling Stockholder”). The underwriters have a 30-day option to purchase up to an additional 1.125 million shares from the Selling Stockholder. Orbitz Worldwide will not receive any proceeds from the offering. Credit Suisse Securities (USA) LLC and Morgan Stanley & Co. LLC are serving as lead joint book-running managers. Deutsche Bank Securities Inc. and UBS Securities LLC are acting as joint book-running managers of the offering. Cowen and Company, LLC is serving as co-manager of the offering.
Travelport Limited was selling 7.5 M out of its 45 M shares that it held in Orbitz. This was roughly 15% of its holdings in the company. It would still hold 37 M shares. Note that Orbitz had around 109 M shares so the 7.5M shares represented about 8% of its total float, a significant proportion.
So why did the stock dip from 7.5$ to 6.7$ or almost 10%? As of May 19th, all of the demand for the stock dried up. People who wanted to buy Orbitz no longer went via the stock market but went via the underwriters doing the deal. This caused demand to drop on the stock market not because the company was not doing well, but because of the economics of the offering. This was purely non economic and this is what makes these situations so special.
So who was selling these shares at 10% below market value? Well people participating in the new offering where buying them cheaper than on the market so people participating in the offering where the ones selling. Our company noticed this event and decided to act upon it. We decided to buy on the open market at around 6.7$. We figured that once the price would be announced and the demand for the stock was back to normal the stock would trade back to its original price of 7.5$.
Four days later, Orbitz published the following press release:
Orbitz Worldwide Announces Pricing of Secondary Common Stock Offering by Selling Stockholder
CHICAGO, May 22, 2014 (GLOBE NEWSWIRE) — Orbitz Worldwide, Inc. (NYSE:OWW) today announced the pricing of a previously announced underwritten public offering of 7.5 million shares of its common stock held by an affiliate of Travelport Limited (the “Selling Stockholder”), at a price to the public of $6.60 per share. The underwriters have a 30-day option to purchase up to an additional 1.125 million shares from the Selling Stockholder. Orbitz Worldwide will not receive any proceeds from the offering. The offering is scheduled to close on May 29, 2014, subject to customary closing conditions.
The press release was published Pre Market and the stock popped 5% up when the market opened. We decided to sell half out position and the remaining a few days later when the stock recuperated.
The risks in this specific deal where:
1) A major shareholder was selling his shares. Did he not like something in the business?
We did some background work on Orbitz and Travelport by reading the prosectus (every company files a prospectus or an S1 when they issue new shares), and we found out that Travelport was simply selling its shares because Orbitz was not part of their long term strategy anymore. Travelport is a backend software that helps Orbitz make bookings. Travelport was using Orbitz to grow their business.
2) Orbitz was not receiving any of the cash but the shareholder was
This is not the optimal situation as it is much better when the company raises the money and they can invest it in the company or deploy it to make an acquisition. This is especially true if the company trades at a high Price / Book. If this is the case, then you are almost certain the stock will recover and will most likely go higher once the company invest its raised capital. The raised capital will also trade at a higher P/B hence making the valuation and the stock price go up.
We determined the odds of the stock rebounding was 80% and the chances of the stock staying at 6.6$ or below was about 20%. We were lucky we knew this company and understood the dynamics of the business and at 6.6$, the stock was actually cheap as it was trading at 9.5X Cash. So we understood that we would either have to hold Orbitz if it stayed there, or sell and loose up to 5%. These were pretty good odds. You have an 80% chance of making 7-8% or a 20% chance of losing 3-5%. We did the bet.
The Results. As you can see from the chart the stock rebounded nicely. We were out within a few days.
There are lots of new issues every week. When the market is up and down as it has been so far in 2014, it could be a nice way to realize some gains. Note that this is a specific skill and I caution investors to start small if they will play these situations. As you get more comfortable you can scale up. Make sure your odds are on your side.