What it means
When a company first lists its shares, the sale is called an initial public offering (IPO). Any later share sale to the public is a follow-on public offering.
The company may need money to fund an acquisition, repay debt, build new plants or strengthen its balance sheet. There are two main types.
In a dilutive FPO, the company issues new shares, so the total number of shares rises, the company receives the cash, and each existing shareholder owns a smaller slice. In a non-dilutive FPO, existing large shareholders such as founders or private equity sell some of their shares, so the company receives no money and the number of shares does not change.
The process is similar to an IPO but quicker, because the company is already known to the market and has publicly available financial statements. Investment banks usually underwrite the offering, meaning they guarantee the sale and charge a fee, which is typically a few per cent of the amount raised.
The shares are normally sold at a small discount to the current market price to attract buyers. The share price often falls when an FPO is announced.
Investors worry about dilution and may read the sale as a signal that the company needs cash or that insiders are selling. Companies try to reduce the shock by explaining clearly how the money will be used.
A rights issue is a related approach in which existing shareholders are offered the new shares first, in proportion to their holdings. This protects them from dilution, whereas a general FPO is offered to the public at large.
Finance teams choose between them depending on the size of the raise, the cost and the shareholder base.
In practice
Real-world examples.
Example
A listed software company announces an FPO of 5,000,000 new shares to fund the acquisition of a competitor. Analysts note that the acquisition should lift earnings by more than the dilution costs. The share price dips 4% on the day and recovers within a month.
Example
A private equity firm that holds 40% of a listed retailer sells part of its stake through an FPO. The company receives nothing, since the shares are existing ones. The sale increases the free float, which makes the shares easier to trade.
Example
A biotechnology business that has used up most of its cash raises new funds through an FPO to complete clinical trials. The finance director explains how the money will be spent over 24 months. Investors participate because the plan is clear and the milestones are measurable.
Formula
Calculation
Ownership after FPO = Shares held / (Existing shares + New shares issued)
Suppose a company has 10,000,000 shares in issue at $50, and it issues 2,000,000 new shares at $48. The gross proceeds are 2,000,000 x 48 = $96,000,000. If underwriting fees are 3% of proceeds, the fee is 96,000,000 x 0.03 = $2,880,000 and net proceeds are $93,120,000.
A shareholder who owned 1,000,000 shares had 1,000,000 / 10,000,000 = 10% of the company. After the FPO the total is 12,000,000 shares, and the holding falls to 1,000,000 / 12,000,000 = 8.33%.Case study
Seen in the real world.
Bayfront Energy is a fictional listed company that needed $120,000,000 to build a new processing plant. The board considered borrowing, but its debt was already high, so it chose an FPO of 3,000,000 new shares at $40 against a market price of $42.
The offering raised 3,000,000 x 40 = $120,000,000 before fees, and with fees of 3% the net amount was $116,400,000. The number of shares rose from 27,000,000 to 30,000,000, so existing holders saw their ownership fall by 10%.
In this illustrative example, the plant came into operation on schedule and lifted annual profit from $54,000,000 to $75,000,000. Earnings per share rose from 54 / 27 = $2.00 to 75 / 30 = $2.50, so the dilution was more than offset by growth.
Watch out
Common mistakes.
- Assuming every FPO dilutes shareholders, when some involve existing owners selling shares and no new shares are created.
- Ignoring underwriting fees and the offer discount when working out how much cash the company will actually receive.
- Confusing an FPO with an IPO, even though the company is already listed and has a trading history.
Questions
People also ask.
What is the difference between an FPO and a rights issue?
An FPO is offered to the public at large, while a rights issue is offered first to existing shareholders in proportion to their holdings.
Why does the share price often drop on announcement?
Investors expect dilution and may read the offering as a sign that the company needs funds, so the price adjusts to the new supply of shares.
Who buys the shares in an FPO?
Institutional investors such as funds usually take most of the shares, with the rest sold to retail investors through brokers.
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