It would be impractical to price a secondary stock offering higher than the market because nobody would buy it: investors have no reason to pay more for new shares when they can buy the existing shares on the open market for less.
A secondary stock offering is when a publicly traded company sells more shares to investors to raise capital. Since the company's stock price has already been established by the market, it is used in pricing the secondary. The price must be set so as to allow the company to raise as much capital as possible while giving the secondary stock buyers an incentive to buy. A secondary price is typically negotiated between the company and the buyers.
Placing and Pricing a Secondary
When doing a secondary, a company must make sure that it can sell the entire issue to raise enough capital. The best way to make sure that a secondary will be sold is to negotiate the placement with large institutional investors who will commit to buying the entire issue. Institutions' goal is to make a profit, so the secondary price must allow them to make at least a small amount. At the same time, the price should not be too low to alienate existing shareholders who may have paid higher prices for their shares. The price is therefore usually set below the market to induce institutional buyers, but not so low as to miff the current shareholders.
Effect of Secondary on Current Stock Price
A stock price often drops when a secondary is announced. Investors believe that companies typically do secondaries when they feel that the stock price is as high as it will get, so they start selling to lock in profits. A secondary increases the current stock supply on the market, which can further weigh on the price. The institutions may hold on to their shares for more profit, but could decide to sell if they feel the profit they have is at risk. Selling for a 50-cent per share profit may not sound like much to a small retail investor, but if you own 500,000 shares, a $250,000 instant profit for a day's work is not bad. If the profit disappears altogether, institutions certainly have no reason to hold on to a losing stock.
Secondary Pricing vs. Stock Price Trend
Secondaries are often done when the stock price is just beginning to decline from its peak; a secondary can accelerate the decline. A quick look at a daily stock chart several months after a secondary will show that the secondary was in fact priced much higher than the market value.
- "PassTrak Series 7: General Securities Representative License Exam"; Dearborn Financial Services; 2003
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