Shares of Party City Holdco (NYSE: PRTY) plunged 8% on Friday after the party goods retailer abruptly announced a secondary offering of 10 million shares. The offering will be made on behalf of selling shareholders, and the company will use a combination of cash and credit facility borrowings to repurchase 2.5 million of those shares.

The key facts

Party City shares had already dropped 27% over the past 12 months due largely to a streak of earnings misses. In 2016, its revenue fell 0.5% to $2.28 billion, its adjusted earnings rose 14%, but its brand comparable sales fell 0.4%.

For the current year, analysts expect its revenue and earnings to rise 4% and 8%, respectively. Those numbers aren't bad, and demonstrate the continuing appeal of specialized brick-and-mortar party supply stores in an age dominated by e-commerce and superstores.

The $169 million Party City held in cash and equivalents at last report was 26% higher than the $134 million it held at the end of 2016, so investors hadn't been expecting a secondary stock offering. Worth noting, of course, is that the company won't receive any of the funds from this offering -- the selling shareholders will. On the other side of the equation, the company finished the quarter with $1.73 billion in debt, net of cash, giving it a net debt leverage of 4.3 times -- so investors probably aren't pleased that it's tapping its credit facility to buy back shares from this offering.

The bottom line

Party City has about 120 million outstanding shares, which makes a 10 million share offering significant. Current investors will certainly suffer some dilution, but the impact won't necessarily make Party City a pricey stock, since it currently trades at just 9 times next year's forecast earnings.

But investors should be wary of Party City's high debt load and its limited growth. A surprise secondary offering designed to allow insiders to sell stock is a red flag, and investors should stay tuned for the company's explanation.

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The author(s) may have a position in any stocks mentioned.


Leo Sun doesn't own any of the stocks mentioned.

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