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Why Did TSLA Just Do a Stock Dilution?

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Miles is a former hedge fund analyst who trades cash stocks, options, spread betting, and CFD.

What Is A Common Stock Offering?

Although there are more complicated forms of offerings including options, convertible notes etc., this article will stick to the basic common stock offering/dilution/placement. A stock offering is simply when a company decides it wants to raise some money in the public markets. The company will usually speak with several investment banks (underwriters in the deal), and issue more of their shares at a specific offering price.

Imagine you own 100% of a company, and you want to raise some money to service some debt interest payments, or build out a new technology. You could sell 5% of the ownership in your company at a specific price, that the banks' MBA "wizards" determine your company is valued at. This example is NOT an offering, but simply selling a stake in your business.

Say, however, your company has 10 shares mapping to 100% ownership (for simplicity), and you own 6 shares (so 60% majority stake). You could issue shares to double the share count to 20, and give yourself 12 shares total (so still 60%). But now an investor who owned a 1 share minority stake (10% previously) might be diluted to having 1 share now out of 20 (or 5%)! This example is exaggerated and simplified, but it gives you the overall picture.

A real-life, classic example of a serious stock offering was when Eduardo Saverin's ownership in Facebook was massively diluted, as shown in the movie, The Social Network. This link from Quora provides more context on how that happened.

What Happens to the Share Price During a Dilution/Offering?

Common sense would tell you that if you own a stock, and the company issues more shares without increasing your holdings, the share price goes down. But as with most things in the stock market, it's not that black and white. Below I detail different, recent examples of stock offerings and their consequences.

DRYS - A Toxic Diluter

DryShips Inc. (since delisted), in my opinion, is a classic example of a toxic diluter. They use marketing and investor speculation to increase their share price and hence valuation, allowing them to issue shares at a high price, bring in cash to management and destroy investor value.

When a company does this often enough, their share price gets too low to meet minimum exchange listing price requirements, so they have to do a reverse-split. This means say cutting the share count in half, hence doubling the price. So if you held 2 shares at $5, after a 2:1 reverse-split, you would own 1 share at $10.

Because a reverse-split doesn't affect shareholder value explicitly (but it would obviously affect the price chart), the historical price chart needs to be "back-adjusted" for this corporate action. This is why the historical price for DRYS looks so crazy, because reverse-split adjustments result in multiplying the past time series by the factor the split was completed at.

The price chart for DRYS below is emblematic of a toxic dilutor, which you now can easily spot! However note - THIS DOESN'T MEAN THIS STOCK IS A GOOD SHORT! Assuming you could find shares to short anyway, you would pay a very high daily borrow rate. Furthermore, because of all the short interest, this stock had an epic short squeeze from around $4 to $102 dollars in several days back in 2016.

DRYS Adjusted Historical Price Chart

PSTV - When Dilution Is A Killer

PSTV back in September 2019 had a market cap < $10M and traded on the NASDAQ. After announcing a reimbursement payment of $4.6M (huge considering their size), their share price rose from $8 to $16 in a matter of hours. Long traders got crushed however, as mid-way through the trading day, the stock was halted and the company announced an offering. The stock plummeted to below $4 within moments of the news breaking. However it wasn't the fact that the company had done an offering that was necessarily bad. It was the fact that the stock was trading around $16, and PSTV announced the pricing of 1 common share + 1 warrant at a combined value of $5!

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The moral of the story here is that the pricing of the offering is generally more important than the offering mechanism itself! We will cover 2 more examples below.

PSTV 1-Y Historical Price Chart

TINO - When Dilution Is A Blessing

On 19th September 2019, Tamino Minerals Inc., an OTC stock whom, back in August had already disclosed that they would be conducting a private placement, released details on the pricing. The stock was trading at $0.0035 (yes, you read that correctly) the prior day, and Tamino, right before the opening bell, announced their offering had placed 15 million units at $0.1.

So although they were conducting a dilution to shareholders, the private buyer was willing to pay $0.1 per share, when the market value was currently $0.0035, representing a nearly x29 premium! During the course of the next several hours, the stock rallied to a high of $0.01, nearly +200%. Although this isn't an insane move in the OTC world, and although it could have gone a lot higher (but didn't), this is a classic example of when the pricing of a placement/dilution is so attractive relative to the current market price, that the corporate action is bullish.

TINO 1-Y Historical Price Chart

Where Does TSLA's Recent Dilution Fit In?

Tesla has had a crazy price increase, even in 2020, which can be largely attributed to a short squeeze of retail and institutional traders alike. Even at the start of this year their share price was around $400, which already was at the highest point since inception.

Tesla's management, seeing the palpable increase in such a short period of time, hitting $960 just a week prior, clearly saw an opportunity to raise money at a breaking valuation. Looking at Tesla's Form 424B5, filed with the SEC on 13th Feb 2020, we see the details of the offering:

Tesla say that the market price on the close of cash business (on the prior trading day) was $767.29. Further on down the document, they say 2,650,000 shares are to be issued for net proceeds of approximately $2.01B, pricing the shares right at market. Considering the share price was around $180 just 7 months prior, and $400 just a month earlier, pricing at market was seen as a very bullish signal (hence the price action back to over $900 at the time of this article). If they had of priced at $350, for example, it would be a completely different story.

TSLA Price Chart - Since Inception

In Summary

In summary, an offering can be good or bad for investors, it really depends on the pricing of the stock.

In this article, we have seen examples of toxic dilutors, bloodbath dilutions as well as dilutions that have increased the price of the stock. In most circumstances however, you should be wary if a stock goes up too much too quickly, an offering may be on the way, especially if the company has demonstrated a past habit of doing it.

As always, do your research and have good risk management.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

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