Companies issue secondary offerings to raise capital or because major shareholders want to sell and dumping that supply on the open market can significantly decrease share prices. These shareholders may also include the company, allowing capital to flow back to their bottom lines through both diluted and non-diluted mechanisms. (On a related topic, see: When Insiders Buy, Should Investors Join Them?)
Whatever the reason, the activity impacts the price chart and forces a reexamination of underlying technicals, especially in regard to accumulation/distribution. Fresh share issuances increase the float, diluting the value of existing shares, while shareholder sales can have a negative impact on other investors who believe it’s a warning sign about future prospects. (For more, read: Trend-spotting With Accumulation/Distribution).
Price action into and after the offering sets short term technical conditions, with new shares establishing support when the security closes above the offering price and holds that level for a few sessions. Conversely, a bearish reaction to the sale, dropping the security below the offering price, establishes that level as notable resistance.
In addition, the initial press release often sets off a downward spiral that forces the offering price well below the market price prior to the announcement. This selling pressure can be overcome with a strongly bullish reaction on the offering day, or it can establish a second resistance layer that slows, stalls or ends an uptrend.
Impact of Massive Dilution
The offering size compared to total shares and outstanding float has a psychological impact as well, with high dilution levels likely to unsettle remaining shareholders, forcing them to reconsider their exposure. A massive offering will also lower price rate of change over time, forcing the security into a smaller range that reduces long term profitability of existing positions.
Citigroup (C) shows the technical impact of massive share dilution when the company was forced to issue new shares multiple times to stay afloat after the 2008 financial crisis and pay back loans from the Federal government. In post-split terms, the stock traded in a 555 point range between 2000 and 2008 but just a 56 point range between 2009 and 2015.
The biotech sector routinely issues more secondary offerings than other market groups, with the majority of small players showing weak or non-existent revenue streams. The high burn rate can force them back to the offering table many times as they move drug applications through the pipeline, to eventual FDA commercial approval or rejection. (For more, read: The Ups And Downs Of Biotechnology).
Biotech investors generally show patience with new and diluted shares, often using the opportunity to build positions at lower prices. It’s a different story with traders with their sensitivity to short term price action. In fact, many traders will sell open positions as soon as a secondary is announced because it adds an unquantifiable risk factor. (Learn more in: How To Do Qualitative Analysis On Biotech Companies).
Small cap biotech Cerulean Pharmaceuticals (CERU) ground out a breakout pattern at 8.25 in the 1st quarter of 2015 and headed higher, posting an all-time high at 10.87 on 19 March. Company executives use the rally as an opportunity to file for a $50 million secondary offering, reported in the pre-market on 31 March, when the stock was trading at 9.50. The initial news had little impact but selling pressure picks up quickly, dumping price through the breakout level.
The company lowered the offering to $30 million on 6 April, one day before the sale but the smaller size didn't appease nervous shareholders, who continue to dump positions. These headwinds force a quick sale of 5.84 million shares near 6.50, which is 31% lower than the price traded prior to the announcement. Shares continue to lose ground into late April, with the offering price setting up new resistance.
A secondary offering can generate significant technical changes to the price chart that require a rapid readjustment by investors and traders.