Yahoo! U presents: The basics of equity offerings

Myles Udland joins Brian Cheung for a special edition of Yahoo! U to explain the basics of an equity offering to the Yahoo Finance Live audience.

Video transcript

MYLES UDLAND: And something that has come up as we have seen a number of these stocks go significantly higher in price is the pressure it does or does not put on corporate management to issue additional shares. Brian Cheung joins us now for a special edition of Yahoo U exploring the world of stock issuance.

BRIAN CHEUNG: Well, class is in session. And today, we are talking about stock issuance. So if Yahoo U 101 is all about IPOs, that means Yahoo 201 might be about secondary issuance or stock issuance after a company is already public. And we saw that this became an issue with AMC when we were talking about obviously the new stock that it had authorized in April but actually sold last week.

So let's explain the pros and cons of issuing new stock if you are using a theoretical company. And wait a minute, is that Yahoo Finance's Myles Udland over there? I mean, it turns out he has a shoe company and it's public already. Now, he's got a million shares outstanding, right, and he wants to raise more capital to, let's say, expand his summer barbecue sneaker line. So he's going to try and sell a hundred thousand new shares.

Now, these two shareholders in Myles' Shoes-- let's call them Julie and Brian here-- they're not necessarily happy with this decision because when a company issues more shares, that's going to increase the number of stakes in a pie that's still the same size. So if the new shares also have voting power, one effect of this is going to be that Brian and Julie will have less voting power because their portion of the overall outstanding shares got smaller.

Now, the bigger deal is that second bullet point there, right? The earnings from Myles' Shoes are now divided up among more shares, which means that Brian and Julie are entitled to fewer earnings in the company since they have to share it now with more people. And this, by the way, is called dilution, like when you water down a drink. Now, for Myles this may be the cost of doing business. So let's say this is where shares of Myles' Shoes have been trading over the last six months or so.

Now, if he sees that his stock has been going up, which has been the trend in June, he may say, well, OK, now is the time to cash in. And that's because if he's going to issue a hundred thousand shares when he's trading at $16, for example, which is close to where it's trading right now, that's going to net him more money than if he issued the same amount of shares at the beginning of the year when he was trading, let's say, at $9, right?

So what happens to a stock price after a secondary offering? Again, Myles hasn't necessarily done this yet. What should we expect? Well, generally, the price is going to go down because of dilution, as I explained. Shareholders see a little less value in voting and also just earnings per share. Now, again, I said "generally." But let's say there's another company, OK? A company that's different, a company that's built different. I'm talking Cheung Shoes different, OK?

So I'm a shoe manufacturer, and I'm going to try to pull the same maneuver here, right? I've got a million shares outstanding. I'm going to do the same thing, issue a hundred thousand new shares. And the question is, what's different about me? The difference is I am a meme stock. So shares in Cheung Shoes have been rocketing to the moon, and I'm thinking about this the same way that Myles was, right? I'm going to cash in when my stock price is high, as you've seen in June.

Now, the difference is that my stock is 31 times where it was in the beginning of the year, and that is showing no signs of stopping. And all fundamentals have fallen apart at this point, which means that the standard rules don't apply. Now, people are going to recall from previous Yahoo U's that Cheung Shoes was in trouble. In fact, we were considering filing for bankruptcy.

But the meme surge has actually helped me here. And that's because now I can raise capital, which means my balance sheet might actually look a lot better now. So there's a fundamental story there. But the idea is that my esteemed retail shareholders, let's say it's still Brian and Julie in this case, they didn't really care about the fundamentals to begin with. They didn't expect my stock to go up 31 times anyway. So even if post-stock issuance, my stock now goes down to let's call it 29 times their original investment, they'll be fine.

Now, one important sidebar I want to point out is that stock issuances don't come from nowhere. You look at this AMC perspective. So this is the real-world application here. Notice the language. It says they authorized the right to maybe sell from time to time up to 11 and 1/2 million shares. And this is important because it means that a stock price might already reflect dilution even before the company actually issues and then sells the new stock.

But either way, guys, the meme stock phenomenon just really shows how traditional dynamics, which is something that's usually as cut and dry as just issuing new stock, are different when there's to-the-moon mentalities in retail traders. And, by the way, I want to close off by saying Julie and Brian will be receiving a free pair of shoelaces for their service in sending Cheung Shoes to the moon. But that wraps up this week's Yahoo U, guys.

MYLES UDLAND: Well, they get new shoelaces, and all my shareholders get is a little bit of dilution. But, look, I'm comfortable with the fundamentals of the business. Clearly that's a nice looking stock chart. We're seeing margin expansion. We're really exerting operating leverage on our model as the economy recovers and people go back outside and restock their closets--

BRIAN CHEUNG: We got a value guy over here, value.

MYLES UDLAND: Look, you have a much more challenging story to tell your shareholders, as they look at that kind of stock price action and try to figure out what's real and what's not in the world of Cheung's Shoes. All right, Brian Cheung, thanks for stopping by for a very special edition of Yahoo U.