How do you tell when a company’s plans to raise more cash are good news or bad?
You often see companies (particularly small ones) coming back time and again to the market to fund their expansion. On the various bulletin boards around the web, the company's cheerleaders will invariably cite such action as a chance to top up, to average down, to get a toe-hold in this exciting business, blah, blah, blah... Heck, I was guilty of it myself with Renold's (LSE: RNO) placing and open offer a couple of months ago, and with Aminex (LSE: AEX) before that last summer, which did the same.
The difference is that was right of course! Aminex has put on a huge spurt since then and I do think the move was sensible for Renold, that the chain maker will come good and that it will prove to have been a smart move in hindsight.
Hypocrisy
So, yes, I'm a complete hypocrite, BUT...
OK, there is no 'but'. But... many smaller companies with terribly exciting futures due to imminent oil strikes, technological breakthroughs yet to be recognised by the $66bn a year market, earnings going through the roof three years hence, the inevitable big deal just around the corner etcetera, etcetera ... come back to the market more than once for a cash boost.
This is a potential red flag for me. As with all such situations, the trick is in deciding which are genuine. The devil is always in the detail -- and that's what makes the investing world go round I suppose.
Why bother?
But with so many companies to choose from that present genuine value and the potential for good growth that don't continually (or ever...) come back with the begging bowl; why bother? The answer, of course, is the excitement. The companies usually have an exciting story to tell that will reward investors taking up the offer handsomely if all goes according to plan...
Small companies, in particular, often seem to have in place overly complex funding arrangements which, though intended to avoid dilution, ends up with them coming back to the market for more cash at a later stage to pay off unsightly debt arrangements (earlier heralded as being the salvation of the company). These are usually at a much lower share price thereby resulting in increased levels of dilution.
Cynicism
The cynics among us may think that such actions are a way for the directors to maintain highly paid prestigious positions as long as possible. Far be it from me to suggest such a wicked thing! But we've all seen exciting early stage development companies selling wonderful stories coming back to take water from the well a couple more times as the story develops.
This implies that some directors are tantamount to crooked, which I don't generally believe, though some are. I'm sure that in most cases, the directors do passionately believe in the company's potential, but stock market history has shown us countless times that the directors aren't the most objective judges.
I also think there's something about the "need" in many people for an "important" role in life (particularly for men, it seems, though this is amateur anthropology) perhaps with mixed with a little pomposity and a blinkered vision about a company's importance and future prospects in the real world.
Then again, some companies come back to the market for cash which is perfectly justifiable. The directors are steadily building value and need money for that process, from which the patient investor taking up the offer will benefit in time.
Of course, the trick is to find the bona fide ones, which you can only do by learning the knack of reading between the lines, looking at the financial detail and directors' track records, and by carefully judging for yourself whether the investment is valid. In particular, try to judge whether previous monies have been shrewdly put to good use -- or whether they've gone down the pan in salaries, expenses, and general hogwash. Good luck!
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