Five Signs Of A Good Financing

Aaron Hodson Mar 15, 2014

This article orginially appeared in the National Post, March 15, 2014. To see it in the paper, click here.

Investors should generally dislike companies that issue stock because it's better if they are self-financing and don't need to dilute their shareholder base.

However, companies do need to grow, and financing is one of the prime reasons the stock market exists in the first place. Rather than dismiss all financings, here are five points to consider in determining whether one is good or bad.

A new share issue should be priced higher than the prior one

This seems so basic, but stocks are supposed to go up. When a company issues stock at a lower price than its previous issues, it just makes us … mad.

For example, BNK Petroleum Inc. (BKX/TSX) on March 5 announced a $35-million bought deal at $2.20 per share. That deal sounds good until you look back and see that the company in 2010 sold $45-million in new shares at $2.85 per share. Buyers of the prior deal haven't made money, so we wouldn’t get overly excited about the current deal.

By contrast, Avigilon Corp. (AVO/TSX) went public in 2011 at $4.50 per share. Its next issue was in 2012 at $6.40 per share, and then it sold shares in late 2013 at $24.10 per share. All of its buyers in these deals are happy, with the stock at around $31. Happy shareholders mean higher valuations to the company.

No increase in the deal size

Enterprise Group Inc. (E/TSX) last week announced a $12-million bought deal. Within minutes of the announcement, underwriters changed the deal size to $24-million. Sure, demand was strong and it is a decent company. But doubling the deal size can tend to soak up all the demand for the stock, and result in a stock that languishes after the deal is completed.

Companies should take what they need in a financing and nothing more. Enterprise thought it wanted to raise $12-million. What suddenly changed to dictate that it now needed $24-million?

Insider participation

We like to see insiders buy new shares alongside other investors. If we are going to recommend a stock, we want management committing their personal funds as well.

Knight Therapeutics Inc. (GUD/TSX-V) last week announced a $71-million private placement. A company controlled by the chief executive agreed to purchase $21-million worth of stock in the new deal. Now that is a commitment. Knight is a new company spun-off from Paladin Labs Inc., but it is certainly off to a good start with this deal.

No sweeteners

We just cringe whenever we see warrants or other sweeteners attached to a financing. Issuing such attachments is, to us, akin to a bribe to potential shareholders. “You don’t want just common shares of our company? How about we throw in half a warrant as well?”

Warrants bring out a different type of buyer, typically hedge funds that short the stock against the warrant, or shorter-term players looking for a leveraged pop from the warrant.

We also don’t like most convertible debentures, because they include the obligation to pay interest. We prefer that a company issue regular, plain old vanilla common shares. Nothing fancy: straight equity with no commitments.

A clearly defined use of cash

It always makes us wonder when a company raises money for ‘general corporate purposes,’ and not in a good way. We know that the line is often just thrown out as a tag in a press release, but a company should know exactly what it wants to do with its new cash.

Many companies raise cash as a cushion, which is fine, but too much cash can be a drag on the returns a company makes.

It's preferable if a company issues stock for something specific, say, bridging an acquisition with debt. Shareholders then know where the proceeds of the issue are going, and do not have to hope that the company does something smart with their money.

As stated initially, we still prefer companies that don’t need money, such as Enghouse Systems Ltd. (ESL/TSX) or Winpak Ltd. (WPK/TSX), each of which is sitting on more than $100-million in cash right now. But if a company is going to raise money, it should at least do it right.



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