What happens to the share price when new shares are issued?

Sudarshan Kadariya, New York

To understand the FPO and its effect on stock price, let’s first discuss the differences between Initial Public Offering (IPO) and FPO. It helps us to understand the reasoning behind these two popular terms frequently use in the stock market.

1. IPO is an offering of shares by an unlisted company to general public aiming to go public and to list the company’s shares in the stock market whereas FPO refers an offering of common shares of the listed company to the general public beyond its first time with new investment prospectus detailing the requirement of the additional capital to the company.
2. IPO is the first public issue of the company’s shares whereas FPO could be second or third or so on public issue of the shares of the listed company.

• In general, IPO is considered riskier investment in the investment community than FPO. In the case of FPO, the investor has already known the performance of the company whereas in the case of IPO, investors put their money relatively on higher risk since they are investing in a new company.

The process of FPO has impact on share prices in the market, most of the time, FPO push the stock price lower because of the dilution, meaning the proportionate decrease in the intrinsic the value of each stocks and at the same time, the decrease in existing shareholders' ownership of a company as a result of issuance of additional shares. The FPO increases the total shares outstanding of the company which has a dilutive effect on the ownership of existing shareholders.

For example, if an investment company X own 10,000 unit shares of a listed company XYZ with 100,000 units of shares outstanding, the existing ownership of company X is 10 percent. If XYZ come up with 50,000 units of FPO then after the offering, the percentage of ownership of the company X will decrease to 6.67 percent only. Similarly, EPS, the best performance measure of the company, would also have the similar dilution effects. The similar effect will appear in other accounts parameters. The increase in numbers of shares outstanding results the decrease in Earning per Share (EPS) which leads to increase Price Earnings (P/E) ratio, the most important investment indicator many investors base their investing decisions.

On the other hands, the market capitalization of the listed company will go up by the market capitalization of the FPO. When the company decides its FPO price, it’s always been lesser than the existing market price of the stock which encourage the potential FPO buyers and on the other hands, the process of FPO depress the value of the existing shareholders. Thus, FPOs are not always appealing to the existing shareholders of the company in the short-run unlike rights and bonus shares offerings.

For example, a company has 100,000 shares with market price of 10 per share. The market capitalization, value of the whole company, before the FPO is therefore 100,000 x 10 = 10,00,000. If the company completes its FPO of 50,000 shares at 9 per share, then it will raise 450,000 which makes the new value of the company (after FPO) 14,50,000 with 150,000 shares outstanding resulting 9.67 per share, or a 0.33 reduction from the original price of the stock in the market i.e. the portion of exiting shareholder would lose due to FPO.

Conclusion:

Despite the cautious discussion above, there are so many upsides of raising additional capital through FPO. The company would take benefits of using shareholder’s equity to expand its businesses primarily, pay-off its high interest paying loans, investment in more profitable segments of its businesses, reshape the existing capital structure of the company to attract more potential low cost lenders and banks, etc. All these benefits would increase the ultimate value of the company to make both (pre-FPO and Post FPO) shareholders happy on their investment decisions only if with the proper use of the additional funds collected through the FPO.

(*the author is a TU Gold medalist in M. Phil in Management with specialization in Finance in 2012. Now, he is working for a consulting firm in New York. The opinion presented in the article is his personal. You could reach him at su.kadariya@gmail.com).