When reviewing a company’s financials, it is crucial to review the cash flow statement. Quick refresher course: the cash flow statement is broken down into three components – 1. Cash from operating activities 2. Cash from investing activities and 2. Cash from financing activities. All are important in their own way. We tend to focus primarily on the cash from operating activities section, but we need to analyze all levers of cash flow in the firm.
My topic today covers share issuance and potential dilution. I am using Itron Inc to illustrate my point. The company has been very popular over the last ten years as its stock multiplied tenfold. They are positioned in a definite sweet spot - their products help utilities automate and monitor usage with products such as modern metering and data collection. Hard to argue with the industry’s potential growth. However, today I am focused on the dangers of share dilution.
A company will often go to the markets to raise capital for potentially very good reasons. They might need capital for expansion, acquisitions, etc. We most want to seek out companies that can self-fund. That is – they have positive free cash flow and don’t need to depend on the whims of the capital markets to raise funds. Typically, debt financing is preferable to equity financing as equity financing can be very expensive (think massive investment banking fees). This is why it is so discouraging the see a company such as Itron dilute existing shareholders. Below is a section from the company's statement of cash flows -
ITRI shares outstanding have increased over 55% for the past five years – that’s almost 10% annually. In fairness to the company, some of the equity proceeds were used to pay down debt – debt that was accumulated from a large acquisition in 2007. The acquisition has definitely grown revenues, but unfortunately has been a major hit to margins. Time will tell whether the acquisition was beneficial. Far too often this type of deal grows the company but destroy economic wealth. It is an incredibly difficult economic hurdle to overcome as the company’s equity base expands rapidly and it diluted.
Moral: growth can be good, but check to see how a company is financing that growth.
My topic today covers share issuance and potential dilution. I am using Itron Inc to illustrate my point. The company has been very popular over the last ten years as its stock multiplied tenfold. They are positioned in a definite sweet spot - their products help utilities automate and monitor usage with products such as modern metering and data collection. Hard to argue with the industry’s potential growth. However, today I am focused on the dangers of share dilution.
A company will often go to the markets to raise capital for potentially very good reasons. They might need capital for expansion, acquisitions, etc. We most want to seek out companies that can self-fund. That is – they have positive free cash flow and don’t need to depend on the whims of the capital markets to raise funds. Typically, debt financing is preferable to equity financing as equity financing can be very expensive (think massive investment banking fees). This is why it is so discouraging the see a company such as Itron dilute existing shareholders. Below is a section from the company's statement of cash flows -
Cash from Investing Activities | -53.99 | -67.08 | -1,714.42 | -85.5 | -30.57 | ||||||
Financing Cash Flow Items | -4.7 | 0.5 | -20.18 | 0.95 | -0.36 | ||||||
| |||||||||||
Total Cash Dividends Paid | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | ||||||
Issuance (Retirement) of Stock, Net | 166.37 | 324.49 | 247.62 | 15.25 | 84.73 | ||||||
Issuance (Retirement) of Debt, Net | -275.8 | -388.37 | 1,082.92 | 302.3 | -111.4 | ||||||
Cash from Financing Activities | -114.12 | -63.38 | 1,310.36 | 318.49 | -27.03 | ||||||
Diluted Weighted Average Shares | 38.54 | 34.95 | 29.58 | 26.28 | 24.78 |
ITRI shares outstanding have increased over 55% for the past five years – that’s almost 10% annually. In fairness to the company, some of the equity proceeds were used to pay down debt – debt that was accumulated from a large acquisition in 2007. The acquisition has definitely grown revenues, but unfortunately has been a major hit to margins. Time will tell whether the acquisition was beneficial. Far too often this type of deal grows the company but destroy economic wealth. It is an incredibly difficult economic hurdle to overcome as the company’s equity base expands rapidly and it diluted.
Moral: growth can be good, but check to see how a company is financing that growth.
