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QuestionsCategory: Management QuadrantManagement Quadrant – Share repurchases
Wilfred Yang asked 3 years ago

In the video, you mentioned about Singleton making acquisitions using the company’s stock and that way it does not dilute shareholders.
Can I check why the shareholders are not diluted? My understanding if a company does an acquisition using shares, those shares have to be issued, which would then cause a dilution to present shareholders.
Something I’m missing here?

3 Answers
Victor Chng answered 3 years ago

Hi Wilfred,
It is based on timing of the valuation. What Singleton do is that he issue shares at high valuation while share buyback at low valuation. By doing so, the original shareholders benefit from the move. In the case of, management issuing shares when the company is at low valuation, it will cause dilution. 
For instance, if I bought the shares at $1 and the management decided to issue share at $0.5, this is dilute my shareholding. Whereas, if the management issue the share at $2 then it does not really dilute me since I bought it at $1.

Wilfred Yang answered 3 years ago

Hi Victor
Thanks. My interpretation of dilution is the ownership of the company. For example, if there were 1000 shares floating and 1000 people each own 1 share, then their ownership is 1%. When new shares are issued, say 1000 shares issued and only 1 person bought all those 1000 shares, then 999 of those who did not buy actually got their ownership diluted. Their ownership would drop from 0.1% to 0.05%. In the event of a dividend distribution, then it’s detrimental to the shareholder. 
Using your example, if you bought the share at $1, and it rises to $2, you then have a $1 paper profit. In the event of a share issuance, the EPS will be reduced and the share price is likely to dip in the short-term. That reduces your paper profit for the short-term. Of course, if the equity raised from the share issued is invested in a good company which adds to the earnings, then in the long-term this would be beneficial. But dilution in terms of ownership will still exist until the share is bought back. 

Victor Chng answered 3 years ago

Hi Wilfred,
If you talk about dilution in term of percentage holding then it does affect. 
What I am trying to explain is that for instance my company market cap is $100m with 100m shares standing. If I own 50% shareholding that will worth $50m. In the event where my company decided to raise another $50m by issue 25m shares at $2 each. The dilution in term of my shareholding will be 25m shares which means instead of 100m shares, now the company have 125m shares.
So at $2 share issue, based on 125m shares outstanding, the market cap will be $250m. Since there is dilution, my 50% shareholding will then reduce to 40% (50m/125m). Despite having shareholding reduced to 40% but my value actually increase from $50m to $100m (0.4 x $250m). Do note that in the event of share issue at a higher price, the share price will adjust to the issuing price which is $2. In this case, I think if we talk about dilution, I felt it is minimum unless it is issued below the price you bought. 
As for the EPS case, yes it does affect the EPS amount if the company maintain the same earnings but if the earnings are still growing then in short term despite issuance of shares, the company share price will either maintain or go up. In the event that the EPS drop 50% and cause the share price to tank 50% too. The market cap will reduce from $250m to $125m and if the management use the $50m that was raised previously to repurchase shares at $1, your share count will reduce to 75m ($50m/$1 gives 50m shares which deduct from 125m share count). This move immediately increase back the EPS and if the EPS recovered then it will be benefiting the shareholder.