Secondary Offering

Secondary offering in the share market refers to the sale of a publicly traded company’s stocks by an investor to the general public in the secondary market. These are company shares that were already sold through an IPO (initial public offering). Since the secondary stock sale transaction happens between two investors, the proceeds from the sale go to the original shareholder selling his shares rather than the company.
 

However, secondary offering can also refer to the issuance of additional shares by a company after its IPO to raise additional funds. In this case, it's more commonly known as a follow-up offering.

• A secondary stock offering occurs when investors sell their shares to the general public on the secondary market after an IPO.
• Secondary offerings can also happen when the publicly traded company issues fresh shares to sell to the public and raise more capital.
• Dilutive secondary offerings dilute the value of each share for existing investors, while non-dilutive offerings do not dilute the value of existing shares.
• Secondary stock offerings can offer investors liquidity benefits and a chance to purchase shares at a discounted price. However, it can also result in stock price declines and negative market sentiments about the company’s financials.

Private companies can float an IPO or initial public offering to raise capital by selling their shares to the public. As the name suggests, an IPO is the first time the company offers its shares to the public. The shares are sold on the primary market, and the capital generated goes to the issuing company. Capital raised through an IPO can be used for various purposes like funding day-to-day operations, financing mergers and acquisitions, or other business activities.

After the IPO, investors can make a secondary offering of the company’s shares on the secondary market. In other words, investors who have bought shares in the IPO can sell their shares on the stock market to other investors. In the case of a secondary stock offering, the money from the transaction goes to the investor selling the shares instead of the issuing company.

Secondary share offerings can be classified into the following two categories:

• Non-dilutive secondary offering: Non-dilutive secondary offering involves trading of shares already issued in the IPO. Since a non-dilutive secondary offering does not involve the creation of new shares, the value of existing shares does not get diluted. In short, it involves the sale of company shares by shareholders on the secondary market. The issuing company may not benefit from a non-dilutive secondary offering since the shares are sold by private shareholders looking to diversify their holdings. This type of secondary share sale is quite common in the years following an IPO once the lock-in period ends for company insiders.
• Dilutive secondary offering: A dilutive secondary offering occurs when a publicly traded company decides to issue fresh shares after its IPO. It is also commonly known as a follow-on public offering or FPO. Dilutive offerings take place when the company’s Board of Directors decide to raise more capital through the sale of equity. Since the company creates new shares for such a secondary offering, it dilutes the value of its existing shares.

Under a dilutive secondary offering, the earnings per share or EPS declines due to a rise in the number of outstanding shares. This means each share is entitled to a lower portion of the company’s earnings, making dilutive offerings unfavourable for existing investors.

Let’s review the benefits and risks of secondary share offerings:

Benefits:

• Liquidity: A secondary offering allows existing investors to enjoy liquidity benefits. They can sell their shares to other investors in the market and redeem the invested capital to meet cash flow requirements, realise potential gains, or seize other lucrative investment opportunities.
• Potential discounts: Generally, companies decrease the price of their stock during a follow-up offering. Therefore, investors can buy the shares of growing companies at a discounted price and later sell them for a profit.
• Expansion of investor base: By initiating a secondary offering, companies can effectively expand their investor base. They can attract new investors and grow the capital reserves.
   

Risks:

• Dilution in share value: Issuing new shares in a follow-up secondary offering dilutes the value of existing shares. When the company adds new shares to the pool of existing shares, the ownership stake, voting rights, and earnings per share of existing investors decline.
• Price volatility: The announcement of a secondary offering can impact share prices, resulting in short-term volatility. This short-term volatility may persist as long as the market adjusts to the additional shares and increased supply. Generally, follow-up offerings post-IPO that dilute share value witness price drops.
• Negative market sentiment: A secondary offering can be interpreted as a negative sign by the market and investors, especially if institutional investors are liquidating their holdings in the company in a non-dilutive offering. It can be viewed as a sign of financial trouble in the case of dilutive offerings. Negative sentiments further impact the company’s share price and reputation.

As an investor, you must be careful when assessing a secondary offering. Here are a few factors to consider when evaluating a secondary stock offering:

• Purpose: If a company has announced a follow-up secondary offering after its IPO, you should consider reviewing the purpose of the offering. In other words, you must try to understand why the company is trying to raise additional capital. Common reasons may include expansion, debt repayment, or operational needs. Understanding the reason for a secondary offering will help you understand if investing in the company is prudent.
• Pricing: You also need to review the stock price for the secondary offering. Compare the offering price to the stock's current market price to evaluate its potential value or discount.
• Dilution impact and market sentiment: If it is a dilutive secondary offering that will issue new shares, understand how the offering will impact EPS. Dilution of share value can create a negative market sentiment regarding the company’s health and financials, potentially resulting in stock price declines.
• Institutional investor participation: If institutional investors are selling their stakes in the company post-IPO through secondary offerings, it may be a sign of trouble. They may sell their stake in the company due to weak growth prospects. Since institutional investors and venture capitalists invest in large blocks of securities, share prices can decline steeply when a significant portion of shares are sold at once.
• Company fundamentals: Reviewing the company’s financial growth prospects, general health, debt burden, EPS, cash flow, and performance is crucial before you participate in either a dilutive or non-dilutive secondary offering.

Acknowledging the following trends in secondary stock offerings can help you improve investment planning and make better investment decisions:

• Numerous companies in India have initiated a follow-up secondary offering where they have issued new shares to raise additional capital for expansion, financing debt, and funding acquisitions.
• In recent years, technology companies have often issued secondary offerings to raise funding for their growth stages.
• Current trends suggest a discounted offering rate. To incentivise investments, the secondary stock offering prices are generally 5% lower than the last closing price of the stock.
• In the recent past, the market has sometimes favourably reacted to secondary offering news, resulting in an increase in share prices. This is usually the case when investors view this offering as a means to pay off debt, finance acquisitions, or invest in innovation.