what does the citi stock exchange mean for share price? what does it mean that stocks will be diluted by 76%?

Sensei answered 5 months ago …

I'm not a Citi shareholder and I don't know - nor do I care - what the terms of this specific arrangement is. But I think your question relates more to the issue of "dilution" so I'll try to answer that.

One of the fundamental factors that determines a stock's price is the ratio of its price to its earnings per share - called the Price/Earnings (or P/E) ratio although it's usually stated as a single number (the "1" being assumed.) So, suppose a company owes the government $750, has 1,000 shares outstanding and earns $1,000 (i.e. $1 per share.) If you're willing to pay 10 times that for a share of stock (i.e. a P/E of 10), you'd be prepared to pay $10 for it.

When you buy stock in the "market", you're buying it from someone who already owns it. The company receives nothing from your purchase.

Now, suppose the company decides to issue another 1,000 shares from its "treasury". In that case, you'd be buying stock from the company directly. Your money goes into the company's bank account. Although there are now 2,000 shares outstanding, if they sold you the shares at an amount that was about the same as what the stock is trading for, your financial interest in the company would pretty much remain the same since its assets would have grown by the proceeds it got from the share sale. Presumably, the company because it would use the proceeds of the share sale to expand its business, and "grow" its earnings.

But, until those earning actually happen, they're only "phantom" earnings and can't be relied upon. So, what do we have now? We have a company that earns $1,000 - but there are now 2,000 shares outstanding - only 50 cents per share. Of course, analysts may estimate that the additional money the company received may help expand its business and grow the earnings this year to $2,000. In that case, the earnings per share would not be diluted since $2,000 divided by 2,000 shares is the same $1 per share. With a P/E of 10, the company would still be worth $10 a share.

Now, supposing the government says, "We lent you this money and we want to convert our debt. Like it or not, you WILL give us 750 shares in exchange for that debt." Those 750 shares have a market value of $7,500, but will only wipe out the government's debt of $750! The impact of the interest saved on the debt (and the company's earnings per share) will be marginal, but the number of shares outstanding will now be 1,750. Each share will now only earn about 57 cents.

More shares; less than fair compensation for those shares; little or no increase in earnings.

And that is called ... DILUTION.