Shopify Inc. (NYSE: SHOP) sold an additional 5.5 million shares of stock for $91.00 per share in mid-May.In mid-August 2016, the company took a similar step when it sold an additional 7.5 million shares for $38.25 each. Here's a look at what happened in the most recent secondary offering and what it means to investors.
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Image source: Getty Images.
Why did Shopify sell more shares?
Shopify decided to raise cash to have more money to run its current business and make it even bigger. The company can use that cash for general purposes such as paying employees, buying equipment, renting space for offices, and even acquiring another company. The money itself will show up on the company's balance sheet as an asset, and until the company uses the money it will be invested in short-term interest-bearing investments.This is very similar to when a company goes public through an initial public offering (IPO). The company gets the cash, after fees, and in return gives an ownership stake in the form of shares to the investors who buy into the IPO (or in this case, the secondary offering).
Data source: Shopify.
Prior to the secondary offering, as of March 31, the company had $395 million in cash, cash equivalents, and short-term investments as well as no long-term debt on its balance sheet. The current capital raise will add an additional $488 million to the balance sheet after banking fees are paid.
Shopify can help merchants put a "buy" button on a blog post. Image source: Shopify.
What does this mean for shareholders?
When a company sells more stock into the market, it leaves current shareholders with a smaller piece of the pie. This is called dilution. The number of shares a shareholder owns is a fraction or a percentage of the company. If more shares are added to the market, the shareholder owns the same number of shares but those shares represent a smaller percentage of the company.
For example, Shopify earned $9.1 million in a previous quarter, its EPS for the quarter would be $0.10. Now that there are 5.5 million more shares outstanding, that same $9.1 million in earnings would convert to $0.09 per share. There are simply more shares to divide the earnings into.
In this case, Shopify shareholders were diluted by 6%.
Data source: Shopify. Shopify Class B shares have greater voting rights than Class A shares.
Making a bigger pie
Shopify's growth has been staggering. In last quarter's results, it grew its revenue 75% year over year. Subscription solutions were up 60% and merchant solutions revenue went up by 92%.Although shareholders are diluted when Shopify issues more stock, suppose it uses the cash it raises to substantially increase the size of the business and the company's earnings. In other words, as the company invests the capital, the return on that investment may outweigh the initial dilution suffered by the shareholders. The goal is to make a bigger pie.
Look at the bright side
No investor wants to see their shares in a company diluted. Shopify is a fast-growing company with a pristine balance sheet. It has no long-term debt. As a shareholder, management decided that cash was needed to grow the business even further. It could have taken out a loan, but instead decided to issue more shares to raise the capital it needs to grow the business and keep its debt at zero. Management's judgment that more cash was required may indicate a belief that the company is just beginning to build out its online shopping infrastructure business.
If you invested in Shopify due to management's prowess at navigating the ever-changing terrain, my advice would be to simply look at this capital raise as a small turn in the road with a company headed toward a much larger destination ahead.
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