Investors Can't Get Enough Of Those StocksJeffrey M. Laderman
A Dow Jones industrial average finally breaking through the 3000 mark, a Standard & Poor's 500-stock index posting new highs almost daily, and a once-laggard over-the-counter market outshining them all. Whether the 1991 bull market can keep climbing depends on the pace of economic recovery and an upswing in corporate earnings. But there's another element to consider: the flood of fresh equity offerings that has raised almost $10.3 billion from investors so far this year. Furthermore, as much as $70 billion a year in new equity could hit the market in the early 1990s. Can the market absorb that kind of new supply without cracking?
At first blush, the answer might be no. In the 1980s, takeovers, leveraged buyouts, and corporate stock buybacks vastly reduced the supply of stock. From 1984 to 1990, about $580 billion, approximately one-sixth the market value of U. S. stocks, was taken out of the market. "The big shrink," as many Wall Streeters call it, was a critical force that propelled the most recent bull market.
But the 1990s are another story. Takeover activity is muted, new LBOs are scarce, and most companies are more interested in husbanding cash than buying back shares.
'HEALTHY THING.' The big shrink is over, but that doesn't mean that this bull market will run out of steam. If anything, the rush to equity increases the chances that stocks will keep rising. New equity financing by well-established companies will repair debt-laden balance sheets built up during an eight-year borrowing binge. Dozens of companies taken private in leveraged buyouts will need to reduce debt by selling stock to the public. Banks, too, must turn to the equity markets to raise at least $7 billion to meet their tougher capital standards. All of this will shore up a shaky financial system that has been a drag on investor confidence.
"Replacing debt with equity is a healthy thing," says Steven Leuthold, an investment manager and market analyst. Lowering interest costs can increase profits and give companies a financial cushion to help fend off hard times and face increasing global competition. "We can imagine the market affording higher price-earnings ratios to companies issuing equity," says Steven G. Einhorn, investment strategist at Goldman, Sachs & Co.
In the 1980s, the more leverage a company had, the better the market liked it. "Investors now see the issuance of equity as a positive," says Frederic M. Seegal, co-head of corporate finance at Salomon Brothers Inc. Indeed, they do. RJR Nabisco Holdings Corp. raised $1.125 billion from the Apr. 11 stock sale in order to reduce its $17.5 billion in debt. The shares have since climbed another 6%.
The surge in initial public offerings by smaller growth companies is also a big plus for the economy (table, page 76). It opens the doors of the capital markets to entrepreneurial outfits that have been shut out for years. Indeed, the IPO market is rife with health care and high-tech stocks, which come from the fastest-growing sectors of the U. S. economy. Robert Natale, who writes Standard & Poor's Corp.'s Emerging and Special Situations, warns that if the IPOs are priced way out of line, it could be a sign of too much speculation in the market. But, he notes, "the deals so far have been pretty reasonable."
IN THE PIPELINE. Companies of all sizes are queuing up to sell stock. Besides the $10.3 billion already raised this year, there's an additional $2.9 billion in registration, according to IDD Information Services. Investment bankers say there are billions more that could go into the pipeline soon. "Over the next year, we'll see a quarter or two with $25 billion or more in new equity," says Carmine Grigoli, chief equity portfolio strategist for First Boston Corp.
While the public's attention is focused on the IPO market--with stories of stocks that double overnight--that's not where the biggest bucks are raised. "Everyone focuses on the IPOs," says David Komansky, executive vice-president for equity markets at Merrill Lynch & Co. Inc. "But the most significant portion of the equity calendar is companies looking for add-on equity." It's easy to see why. The average IPO has raised about $34 million this year, and big corporations pick up hundreds of millions of dollars in each secondary offering (table, page 76).
These offerings receive a warm welcome, too. In the past, prices usually slumped when a company announced plans to sell additional stock, since the extra shares increase supply and might also dilute existing shareholders' ownership. But now, huge secondary offerings are being made without dampening the stock price. "Judging from the response," says Vikram S. Pandit, a managing director at Morgan Stanley & Co., "I'd say the market already expects the new equity."
In some cases, an additional offering of stock is just what's needed to give share prices a boost. Adding more shares to the market increases a stock's liquidity, and that's paramount for institutional investors. No matter how attractive a company's fundamentals, large institutions are reluctant to buy stocks that are little traded, lest their own buying drives the price too high. Worse yet, they fear that they will be unable to find a buyer when they want to sell. Take the $887.5 million offering on Apr. 2 gf Dillard Department Stores Inc. stock. The number of shares in the public's hands increased by 25%, yet the stock price has since climbed 20%.
Many companies, too, are tapping a market for the old-fashioned reason -- to expand and upgrade operations. The capital-hungry parents of American, United, and Delta airlines have all sold stock this year. That will give them added financial strength and flexibility to pay for the next generation of airplanes. Delta Air Lines Inc.'s $484.4 million stock sale was its first since 1962.
WEAK SISTERS. Some companies are seeking equity to help fix past mistakes. In late February, for instance, the blue-chip Westinghouse Electric Corp. announced plans to raise $600 million in equity this year. The company is selling shares primarily to bolster its Westinghouse Credit Corp. unit with a $525 million cash infusion.
Even companies in such beaten-up industries as retailing and apparel are planning to sell stock. Among them: AnnTaylor Stores, Caldor, Filene's Basement, and apparel maker Jones Apparel Group. Says Gilbert Harrison, chairman of Financo Inc., an investment bank specializing in the retail industry: "These are the success stories."
Another good reason for companies to sell equity nowadays is that shares fetch a high price. For a good part of the 1980s, the shares of corporations on average sold for 75% of what it would cost to replace the company's assets. In such situations, issuing stock is like giving away $1 worth of assets for 75~. No wonder few companies were willing to raise equity capital. Instead, they borrowed the capital they needed. Today, the market is pricing companies' stock higher than the replacement cost of the underlying assets. This makes equity financing attractive to many that would not have given it a second look only a few years ago.
Likewise, some investors who would have given new offerings only a passing glance a few years ago are buying them now. Michael D. Wolf, a portfolio manager with IDS Equity Advisors, points out that equity holdings of foreign investors, private pension plans, and individuals should increase in the coming years because they are well below historical norms. For instance, equity holdings, including those in mutual funds, are now only 16.7% of household financial assets, compared with 35% in 1968, the peak year. Says Wolf: "Individuals were net sellers of stocks during the 1980s, and they'll be net buyers in the 1990s." If he's right, investor demand for stocks will amply meet the swell of supply. And that could keep this bull market on a steady track.