Here’s how I think about dilution:
First, it’s inevitable. Growth companies need cash, and they issue securities to get it. If they sell securities below fair value, that’s the proper definition of dilution and it’s an unfortunate reality of investing in growth.
Always adjust for the cash needed to execute a business plan. It’s really a liability, so add the current enterprise value to the required cash and think of that as the ‘real’ enterprise value.
Compare your future expected enterprise value to the current ‘real’ enterprise value and decide if the upside is worth the risk. In the cash of OTLK, I think the answer is obvious since clinical trial risk is basically gone.
There are different ways OTLK can raise money.
(a) A discounted placement. This is the worst choice, because the stock would get hit the morning of the announcement and it would feel bad. I invest in private placements a lot and many times the stock will fall about 10% - 20% down to the deal price. In the long run, it won’t matter much, but who wants to ruin an otherwise good day.
(b) Use their equity line. They have one in place. They can issue sell orders under their existing equity and if they sell about 5% - 10% of the market volume, investors will hardly notice. The stock will face a slight headwind, but no one will have a bad day.
(c) Issue debt and then pay the debt off using their equity line. There are some investors that will buy debt in companies like OTLK. It will cost the company about 15% - 20% annualized. It’s expensive debt but if the company thinks their stock should be $4, then they can issue debt now and tap their equity line when the stock is around $4. The debt doesn’t represent a big risk since they won’t default with the equity line in place. This is the best option, though a little complicated. I made this suggestion to management.
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