If you think a rush by companies to sell their shares is a bad omen for the market, imagine a scenario where most of the sales come from firms that don’t make money.
It’s happening now. Since the end of March, almost 100 unprofitable companies, including GameStop Corp. and AMC Entertainment Holdings Inc., have raised money through secondary offerings, twice as many as coming from profitable firms, according to data compiled by Bloomberg.
Granted, troubled companies are tapping into buoyant demand during a 16-month rally to beef up their balance sheets. And it’s further evidence that the capital market functions as smoothly as it’s supposed to. Yet some warn that the flood of shares coming from money losers is becoming extreme.
During the past 12 months, almost 750 money-losing firms have sold shares in the secondary market, exceeding those that make profits by the biggest margin since at least 1982, data compiled by Sundial Capital Research show.
“That perhaps points to companies getting greedy,” said Mike Bailey, director of research at FBB Capital Partners. “Anytime you have a bunch of selling by desperate companies, that could be a signal we’re closer to a top than a cyclical bottom.”
In fact, the previous two periods in which unprofitable firms dominated the pool of equity offerings, the S&P 500 Index was either at the start of a bear market, or already in one.
The 2000 episode showed what might be at stake. Back then, a similarly ebullient market lured profitless companies to offer shares. Once supply overwhelmed demand, the party turned into a scare. Stocks with no fundamental support sold off and the carnage spread to the rest of the market.
“There can be too much money chasing too little good deals,” said Jeanette Garretty, chief economist at Robertson Stephens Wealth Management. “When the good deals don’t need that money, they start looking for less great deals, and then down the road this is what can lead people to get their fingers burned.”
With much of the business world yet to fully recover from the pandemic fallout, the easiness to raise money via equity offerings bodes well for corporate America, according to Randy Frederick, managing director of trading and derivatives for Charles Schwab Corp. With the boost in capital, he says, many crippled firms now have a shot at mounting a turnaround.
Take AMC as an example. After sinking to the brink of bankruptcy during the lockdown, the movie theater-operator has cashed in on its meme-stock status to raise some $1.25 billion through equity offerings in recent months. That, combined with an improving outlook for the film industry, prompted S&P Global Ratings to upgrade its credit score.
Similarly, GameStop has tapped equity markets twice this year in moves that the video-game retailer said would raise money to invest in growth initiatives and maintain a strong balance sheet. Activist investor Ryan Cohen has built a 13% stake in GameStop and is leading an effort to transform the company into an e-commerce powerhouse, away from its brick-and-mortar roots.
An unprofitable firm “could issue shares, get working capital, perhaps change strategy, go into new lines of business, do R&D -- whatever it might be, that could ultimately lead to them becoming profitable and growing the business again,” Frederick said. “That’s why the capital markets exist.”
Read more: AMC Marks Golden Age for At-The-Market Stock Sales: ECM Watch
Of course, there’s no guarantee that a transformation effort will succeed. Based on stock performance following issuance, investors still prefer quality. Among this quarter’s issuers, those that are struggling have seen their shares rise 2.7% on average through Friday, trailing those profitable by 2 percentage points.
Sundial tracks a suite of indicators to gauge the market’s sentiment. That money-losing firms are flooding the secondary market adds to a growing set of signs that point to elevated enthusiasm, according to Jason Goepfert, the firm’s founder.
Scott Knapp, chief market strategist at CUNA Mutual Group, agrees.
“When there is increased appetite for issues from unprofitable companies, it tends to mark a point of euphoria,” Knapp said. “This phenomenon can be in place for a very long time. It’s not necessarily a signal the market is about to reverse. But it is something that typically has preceded a period of reversal in the trend -- the market is more likely to cool down when appetite for unprofitable issuers rises.”
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