InvestorPlace’s Sarah Smith recently reported on Nio’s (NYSE:NIO) plans to sell as many as 69 million shares of Nio stock at the close of Dec. 11 trading.
As I write this midday through Dec. 11, Nio’s share price is $45.22. Assuming the underwriters exercise their option to buy an additional nine million shares, Nio will have raised gross proceeds of $3.12 billion from their stock offering.
As is often the case, Nio’s stock dropped in pre-market trading. No one likes their shares to be diluted.
However, rational investors understand the move by management is capital allocation 101. To not sell stock at current prices would be a failure by management to do its job.
Here’s why.
Nio Stock Is Currency Right Now
Nobody seems to be criticizing Elon Musk for Tesla’s (NASDAQ:TSLA) most recent $5 billion stock offering, its third in 2020.
However, as Sarah reported, investors are nervous about Nio’s stock and this offering for several reasons, the most pressing being the possibility of delisting on the NYSE and increased scrutiny and regulation from the Chinese government.
The company said in its press release that it intends to use the proceeds for three different areas:
“(i) research and development of new products and next generations of autonomous driving technologies, (ii) sales and service network expansion and market penetration and (iii) general corporate purposes.”
Nothing nefarious in those three sentences. If it wants to keep growing the company, it has to keep investing in these two key areas.
People forget that Nio was very close to running out of cash at the beginning of 2020 before working a deal in April with the municipal government of Hefei, Anhui province’s capital city.
Ever since then, it’s been off to the races.
However, it still has to play its capital allocation levers with caution. Management and the board have decided that it needs a few more billion on its balance sheet to get it through 2021.
It has two choices: It can borrow the money or it can issue more stock.
Up 1,024.9% year-to-date through Dec. 10, it’s silly even to contemplate borrowing the funds, regardless of whether interest rates are historically low.
Henry Singleton Would Have Made This Play
Dr. Henry Singleton founded Teledyne Technologies (NYSE:TDY) in 1960. It still exists today. Not only was Singleton a talented electrical engineer and entrepreneur, but he was also one of the best capital allocators in American business.
As a result, I like to use Singleton as an example of when it makes sense to dilute shareholders. As far back as 2012, I’ve talked about his capital allocation practices.
“Henry Singleton, founder of Teledyne — one of America’s most successful conglomerates — used share repurchases with military-like precision to grow his company,” I wrote in 2012.
“When shares were expensive, he used shares to acquire companies; when they were cheap, he bought them back. There was no middle ground for Singleton, and the strategy worked flawlessly.”
As Singleton’s practices apply to Nio, one of his strategies was to build cash for uncertain times. Billionaire investor Leon Cooperman wrote about this in an open letter to Business Week in 1982. Cooperman defended Teledyne’s business practices in the letter stating that “[t]heir record of operating and asset management is second to none.”
Singleton moved between cash, debt, acquisitions, and share repurchases as if he was conducting a finely tuned orchestra. Everything fit seamlessly.
And that’s why I believe management’s move to raise cash through share sales is capital allocation 101. I’m confident Singleton would have approved.
Finally, let’s not forget this is the same management who led Nio out of its cash crunch earlier this year. Until it proves otherwise, I think investors ought to give them the benefit of the doubt.
Bottom Line
I happened to see an article from Benzinga that wondered if Nio’s share price would hit $100 by 2022. It asked 300 investors this question. Almost 77% of the 300 investors answered in the affirmative.
I wasn’t part of the survey, but if I were asked the same question, I too would say yes. A double in two years? Given it will have as many as five vehicles to sell by late 2021 or early 2022, barring some collapse, I don’t see how it misses.
For me, Nio remains an excellent long-term buy, despite the dilution.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
