Hello Mtl_gold,

You’ve quoted me (correctly):

“Dilution hardly counts in such a case because the company will be taken over long
before we get to enjoy anything resembling justice in regards to stock price revaluation.”

You’ve taken issue with me (as follows):

“Let’s say, for example, that Company A has a total of 100 million shares out. Company B then
comes along and decides that they’re willing to pay $500 million to acquire Company A. Well,
that equates to $5 bucks a share. But now if Company A happened to have 200 million shares
instead of the initial 100 million...well, that would leave shareholders with only $2.50 per share.
That’s a pretty big difference, is it not?”

Next, (as follows) you’ve asked me to explain my thinking:

“So please explain to me how dilution ‘hardly counts’ in the event of a takeover.
I don’t understand why anyone would think such a thing...”

Well, as you’ve done, for the sake of clarity, I’ll outline a hypothetical situation with rough numbers, which will elucidate the logic. However, to start with, it would be easier to follow my train of thought if you were to recognize the fundamental error in your example. In other words, your example is good in being clear-cut and easy to explain but, the problem is, it doesn’t hold water.

Implicit in your scenario is Company B’s “willing to pay $500 million” will go unchallenged and will be the final unchangeable reality. What Company B is “willing to pay,” for illustrative purposes (as was your intention), means hardly anything. If Company B were “willing to pay” 25 cents (instead of the $25 million in your example) would you be just as concerned? Obviously, even in a simplified example (such as yours) the relationship of the offer to the actual resources being acquired must be part of the equation, cannot be left out, and leaving it out ruins all your logic and misrepresents the proportions.

So not only is it improbable to assume the “willing to pay” $500 bid will automatically be accepted, it is also improbable to assume it automatically has any relationship to the size of the resources. That’s key here because my point, which you are questioning, concerns that exact question. When I say “dilution hardly counts,” I’m not saying that all by itself. I’m talking proportions.

I’m comparing the size of the dilution to the size of the market’s irrationality. Let’s take a look at that for a moment. If you have an entity the market is valuing at $100 and you enlarge it by putting extra money in the bank, bringing the size up to $125, the market may disapprove (as you suggest) and only value, for example, an entity whose size you’ve increased 25% by, say, 10%. So, what you’re saying (but in my words) is, “You’ve made the company bigger and stronger but at too high a price in terms of diluting the shareholders who preceded the PP. In effect, we’ve paid $25 to bring our value up $10. All of a sudden, completely out-of-the-blue, because of dilution, that’s robbing me of 15% of my investment. No matter what the circumstances, the arithmetic of dilution never changes.”

On the other hand, my points are:

#1) As I’ve just written, the dilution was not pure dilution. We got something for it (money). So, even if we were to limit our arithmetic to the dilution event itself (the PP), the compensation for the dilution is part of the equation, bringing the damage down from a percentage such as 25% to a percentage such as 15%. The real question is: Going beyond the dilution event itself (the PP), has Smith really caused the pre-PP investors percentage damages such as 15% by (in effect) giving away valuable resources and only getting dollars in return?

#2) One day before the message you’ve questioned (“Time is More than Money”), I posted another message (“More than Devil’s Advocacy”). In it, I said: “I’ve concluded, no matter how you slice it, the hard numbers demonstrate (just in terms of titanium) a wild market undervaluation of Magpie whose dimensions are far and away off the charts. I’m talking in the neighborhood of 100 X or possibly more of the entire FNC price for Magpie titanium alone (giving zero credit for anything else in all of FNC).”

#3) As I understand it, your contention is: Dilution is dilution. Good or bad reasons for it, the hurt is the same. The arithmetic doesn’t change. You’re wrong. To start with, even if shareholders were to think exactly as you that the dilution was bad; as I’ve pointed out, it wasn’t as bad as all that because we got something for it (money). You left that out.

#4) If you believe, as I do, that we are likely to be taken over, the date that takes place should be part of your dilution equation because it is a key determinant of what the offer will be. You wrote: “Company B then comes along and decides that they’re willing to pay $500 million to acquire Company A.” We do not live in a world where takeovers always take place at the time and the price “Company B then comes along and decides that they’re willing to pay.”

#5) Your dilution equation also left out the discrepancy between an honest appraisal of takeover values compared to the current market mega undervaluation. The sentence of mine that you question is hardly objectionable: “Dilution hardly counts in such a case because the company will be taken over long before we get to enjoy anything resembling justice in regards to stock price revaluation.”

If the price should be $10,000, should we be arguing about what management did wrong, which resulted in the offer being reduced from $125 to $110? I’m optimistic. No matter what you think of Smith, I’m confident he’s got his own numerical representations of how far we need to go to correct the market’s lunacy. Press releases alone will not come close to doing the job.

You’re missing the point if you’re worried about such proportional injustices as getting $110 instead of $125. What I’m concerned about is on a different scale, such as the proportional injustice of getting $125 instead of $10,000. True, I’m not figuring I’m likely to pocket $10,000 instead of $125. But I am figuring, we should be moving in the direction of changing the market’s perception of our value. That will take us far beyond the $125 in my example. That’s why, doing the PP and earmarking the PP money to achieve that purpose may not turn out to be such a dumb move, after all.