How To Analyse Financing Dilution In Four Separate Ways

Financing dilution is four measurements, not one. Ownership dilution is the proportion of the company a holder ends up with. Earnings dilution is the fall in earnings per share. Book value dilution is the movement in net worth per share. Voting dilution is the loss of influence. The four run independently, and on a single raise two of them can move in opposite directions.

Why does a dilution figure mean nothing until its kind is named?

A raise is described as diluting shareholders by 18.18 per cent. The next question is not whether that is a lot. The same event produces four answers and they do not travel together, so the next question is which of the four has just been measured.

Ownership dilutionThe fall in the proportion of the company a particular holder ends up with after new shares are issued. Ownership dilution is about the slice, not about the money. measures the slice. Earnings dilutionThe fall in earnings per share caused by spreading profit over a larger number of shares. Earnings dilution is about the profit line, not the slice. measures profit spread over a larger count. Book value dilutionThe movement in net worth per share after a raise. Issue above the existing book value per share and it rises; issue below and it falls. The word dilution is a poor fit for this one. measures net worth per share, and on a raise priced above book it is not a fall at all. Voting dilutionThe loss of influence when a block of shares becomes a smaller share of a larger total, even though not a single share was sold. measures influence, and it moves for a holder who sold nothing.

Think of three neighbours who together run a small shop, holding a third each. A fourth person is brought in with fresh money. If the three do not put more money in, each slice falls to a quarter. The fall from a third to a quarter is the ownership reading. Each of them may still end up better off or worse off. The answer turns on what the fourth person paid and on what the shop does with the money, and neither question is the slice. A dilution figure quoted without its kind is not a figure, and the four can point in different directions on the same raise, so picking the wrong one answers a question nobody asked.

What is the procedure, in order?

Eight steps, run in this sequence on any raise by any route. The order is not decoration. Two of the steps decide what the later steps are even allowed to compute, and running them out of order is how a correct arithmetic result ends up attached to the wrong question.

1. Name which of the four is being asked aboutOwnership, earnings, book value or voting. Write the word down before any number is written down.
   Checking: could a reader tell from the label alone which of the four this figure is?
2. Fix the before state and date itShare count, profit after tax, earnings per share, net worth, book value per share, and the size of every block on the register.
   Checking: is every line of the base written down, and does it carry the date it was taken?
3. Count every share that will existAlready outstanding, being issued now, and able to arrive later from anything that turns into equity.
   Checking: has anything convertible been listed, and has anything been left off?
4. Ask who is allowed to subscribeSelected investors, or every holder in proportion. This is asked before any arithmetic is done.
   Checking: can the holder being measured take up their share of this offer or not?
5. The money put to work, or the absence stated plainlyEither the raise funds something with a stated result, or the figure is being computed with the cash idle.
   Checking: does the earnings figure being quoted assume the money earns nothing?
6. Run the book value line separatelyIt is a different line with a different reference, and it does not follow the earnings line.
   Checking: is the issue price above or below the existing book value per share?
7. Run the whole thing for a named holderOne who subscribes, one who sells the entitlement, one who does nothing.
   Checking: whose outcome is this, and would a different holder get a different answer?
8. State what the analysis did not measureWritten into the output, not left to the reader to infer.
   Checking: is there a list of what this procedure has not settled, in the same note?

How is the before state fixed so the comparison is honest?

Step two produces nothing anybody wants to read, and skipping it is how most dilution notes go wrong. A dilution figure is a difference between two states. If the second state is measured against a base that has itself moved, the difference belongs partly to the raise and partly to whatever else changed, and there is no way afterwards to tell which part is which.

Here is the before stateThe full set of figures describing the company immediately before the raise, written down and dated, so that everything computed afterwards is a difference from a base that cannot move. for Harivansh Packaging Limited, an invented manufacturer. Fixing the base is a step in its own right, so every line of it is written out in full and dated.

Two of those lines are the ones people leave out. Book value per share is rarely quoted, so it has to be computed here: Rs 1,650 crore over 18.00 crore shares is Rs 91.67/-. The register split is not one number but a list of blocks. Step seven needs to know how large each block is, not just how large the whole is. The reference price of Rs 300/- is a market price rather than an accounting one, so it is dated with the rest of the base and plays no part in the book value test. A comparison against a moving base is not a comparison, so the base is written down and dated before a single result is computed.

How are the shares that do not exist yet counted?

Step three counts three things: shares already outstanding, shares being issued in this raise, and shares that can arrive later because something already sitting on the balance sheet turns into equity. Nothing about the raise itself brings that third line to mind, and that is where counts go wrong.

Take the placement first. Harivansh Packaging Limited issues 4.00 crore new shares at Rs 285/-, raising Rs 1,140 crore, so the count goes from 18.00 crore to 22.00 crore. The placement count is arithmetic anybody can do. Now suppose a convertible is also outstanding, Rs 1,140 crore converting at Rs 375/-. The convertible delivers a further 3.04 crore shares, and the fully counted share baseEvery share that will exist once anything already issued and capable of turning into equity has done so, rather than only the shares outstanding today plus the ones being issued now. is 25.04 crore rather than 22.00 crore.

Look at what that does to the earnings line, on the same idle money basis for both counts. Rs 225 crore over 22.00 crore shares is Rs 10.23/-. The same Rs 225 crore over 25.04 crore shares is Rs 8.99/-. Earnings on the converted money belong to step five, and they are held out of both figures here so the counts are compared like with like. A count that stops at the current issue understates by exactly the instruments nobody remembered, and the arithmetic gives no warning because it is internally consistent either way.

Who is allowed to subscribe, and why is that asked first?

Step four is the one people put in the wrong place. ParticipationWhether the holder being measured is entitled to take up a share of the new issue, and whether they actually do. Participation decides whether the ownership measurement produces a number at all. is not a detail to note alongside the result. The participation question decides whether one of the four measurements produces a figure at all, and so it is settled before any arithmetic is done.

If the offer goes to selected investors, an existing holder outside that set cannot take up any of it, and their proportion falls by the whole of the new issue over the new total: 4.00 crore over 22.00 crore, or 18.18 per cent. If the offer goes to every holder in proportion to what they already hold, a holder who takes up their full entitlement ends with the same proportion they started with. Not a small dilution. None.

The lower branch carries a condition that matters. The lower branch holds only for a holder who takes up in full. A holder on a proportional offer who does nothing is on the upper branch, and on the rights issue at Rs 190/- that branch is worse than the placement: 6.00 crore over 24.00 crore, or 25.0 per cent. The answer to the participation question changes which calculation is the right one to run, so the question sits before the calculation rather than after it.

What do the four measurements say on this raise?

Now run the whole procedure once, on Harivansh Packaging Limited, comparing two routes that raise the identical Rs 1,140 crore. The placement issues 4.00 crore shares at Rs 285/-. The rights issue offers 6.00 crore shares at Rs 190/-, one for every three held. The before state is the table above. Every figure in the grid below was recomputed from it.

Stop on two cells before reading on. The route with the larger earnings fall, the rights issue at 25.0 per cent, is the route with no ownership dilution at all. And both routes lift book value per share while cutting earnings per share, so on one raise two of the four measurements move in opposite directions at the same instant. A single number here would have to be simultaneously 18.18 per cent, 25.0 per cent, a rise of 38.3 per cent and nil. The procedure produces four outputs and never one.

Why is the day after the raise only a step in the working?

Every earnings figure in the grid was computed with the Rs 1,140 crore sitting in the account earning nothing. The idle money assumption is deliberate. An intermediate result reads exactly like a conclusion, so it has to be labelled as one.

Nobody raises Rs 1,140 crore to leave it in an account. If Harivansh Packaging Limited funds the purchase of Sundarban Polymers Private Limited with it, the target brings Rs 61 crore of profit after tax, a rounded figure the record locks and which the exact chain puts a little higher. Profit becomes Rs 286 crore. Earnings per share on the rights count is Rs 286 crore over 24.00 crore shares, or Rs 11.9167/-, rounded to Rs 11.92/- when it is quoted. Rs 11.92/- is still below Rs 12.50/-, so the raise is still dilutive on the earnings line, but by a very different amount. Quoting the idle money figure as the dilution is the commonest way a raise is made to look worse than it turned out to be.

Why does book value per share move the other way?

Step six is run separately because it is a different line with a different reference. The earnings line divides profit by shares, so a larger share count always pushes it down until the money starts earning. The book value line divides net worth by shares, and the raise adds to both the top and the bottom of that fraction at once.

Which way it lands is settled by one comparison, and it is the comparison instinct gets wrong. The comparison is the issue price against the existing book value per share of Rs 91.67/-. The market reference price of Rs 300/- plays no part in it. The placement at Rs 285/- is a discount to that reference price, and people therefore expect book value per share to fall. Book value per share rises instead, to Rs 126.82/-. Rs 285/- is more than three times Rs 91.67/-, so every new share brings in far more net worth than the average share already carried.

The rights issue at Rs 190/- is priced lower, so it lifts book value per share by less: to Rs 116.25/-, a rise of 26.8 per cent against 38.3 per cent. Both are rises. The reference for this test is book value per share and not the market reference price. The instinct goes the other way, and that is why this step is run on its own line rather than folded into the earnings work.

How does the holder who acts differ from the one who does not?

Step seven is where the procedure stops describing the company and starts describing a person. Take a named positionOne specific holding, of a stated size, run through the whole procedure, rather than an average across everybody on the register. of 100 shares through the rights issue at Rs 190/-, one new share for every three held.

The holder subscribes for 33.33 shares and pays Rs 6,333.33/-. Their attributable earningsThe slice of the profit that belongs to one particular holding: the number of shares held multiplied by earnings per share. were 100 shares at Rs 12.50/-, or Rs 1,250/-. Afterwards they hold 133.33 shares, and on the rights funded earnings per share of Rs 11.9167/- that is Rs 1,588.89/-. So their attributable earnings rose by Rs 338.89/- on a payment of Rs 6,333.33/-, even though earnings per share fell by 25.0 per cent on the idle money basis.

The match between those two percentages is not a coincidence. Rs 338.89/- over Rs 6,333.33/- is 5.3509 per cent. Rs 61 crore over Rs 1,140 crore is 5.3509 per cent. A holder who subscribes in exact proportion has funded exactly their own share of the asset being bought, so what their money earned is what the asset earns, struck on the same kind of base. Rs 61 crore is itself a rounded figure and the exact chain gives a little more, so the rounded figure is carried right through and every result ties to the one before it.

Now run the same event for two other holders, each starting with 100 shares.

The price the entitlement fetches when it is sold is set in the market, so that cell names the absence rather than estimating around it. Everything else is computed. The average outcome across all holders describes nobody on this table. The procedure is run for a named position rather than for the register as a whole.

What has the analysis not measured?

Step eight is written into the output rather than left for the reader to work out. When the four measurements are done, four other things remain untouched, and each of them is capable of mattering more than everything above.

Whether the Rs 1,140 crore earns more than it cost to raise is a question about the future and about what the money would otherwise have done, and no published figure settles it. Leverage changes too, and leverage is a separate reading of the balance sheet. The effect on the next raise is a question about how much room is left. And the influence of any block on the register is settled by more than its percentage. A dilution analysis that ends without this step will be read as a verdict on the raise. A dilution analysis is not a verdict and cannot become one.