04/20/2010 | By Joseph M. Harvey
We at Cohen & Steers are against using ATMs––"at the market" off-the-shelf equity offerings, also known as "dribble-out" or "slow-mo" offerings––to issue common stock, and are asking REITs to put them back on the shelf. Here's why.
Philosophically, ATMs are an end run around the governance and transparency of the public market. Rather than trying to "sneak it out," companies should be open and transparent about their need for capital, and explain how they would use the proceeds of an equity offering. It is a worthwhile process and holds management's feet to the fire. This is one of the economically sound governance principles of the public market that has helped REITs make better capital allocation decisions than private operators. When the use of proceeds is attractive and the financing strategy is sensible, this process expands the demand for a REIT's shares, in our view.
Currently, over one-third of the 106 companies in the NAREIT Equity REIT index have ATM registrations. We are concerned that this could lead to a contraction of industry cash flow multiples due to 1) greater supply of stock in the absence of any marketing process; 2) investor frustration with trading dynamics and lack of transparency; 3) greater variability in analyst estimates; and 4) potential for dilution of shareholders' equity. Simple economic reasoning tells us that if the supply of shares is greater than the demand, the price goes down.
While companies are attracted to the 2% commission on ATM offerings, we believe they are not considering whether the steady stream of dribble-out stock for sale impairs their share price and cost of capital. It should be noted, too, that traditional marketed offering underwriting spreads and investor offering discounts are narrowing from financial crisis levels in excess of 10% to an all-in cost of around 4-7%.
The other argument for ATMs is that REITs can "match fund" sources and uses of capital. We have always argued that a dollar of cash sitting on a balance sheet is not dilutive––it is still worth a dollar, and the public market can figure out what a REIT's normalized earnings power is, assuming full investment of capital. Companies should raise capital when it is priced right and available, rather than spend a lot of time dollar-cost averaging.
More and more frequently, we are colliding with companies on the sell side in our daily trading activity. This can alter our buy programs and curtail demand for the stock. There have been many studies chronicling how poorly corporate America has executed share repurchase programs. We are hard pressed to see how the results for ATM stock sales would be any better.
In the final analysis we believe the REIT sector would be better off without ATMs. Make business simple: if you need capital, be transparent, execute a marketed offering and get it out of the way.