A share overhang is when a company has a large amount of shares in the hands of perhaps one or two holders which, if they were suddenly released on to the market, would ultimately flood it and dampen the share price.

There could be various reasons for a share overhang, it could be a founder looking to exit or a fund manager looking to offload a hefty interest in a stock. They also vary by scale.

PRIVATE EQUITY EXITS

Private equity companies when floating a company will tend to keep a holding in the company once it has gone public.

Oliver Brown, investment director at RC Brown Investment Management, says one reason private equity companies retain part of the business is that investors like to see them to keep ‘skin in the game’. This helps reassure potential investors that there is nothing fundamentally wrong with the business.

Brown was a buyer when Hollywood Bowl (BOWL) floated despite its private equity owners selling out completely. However, in this instance the private equity house had been approached by an investment bank saying there were plenty of buyers to meet the demand.

One of Brown’s funds, MFM UK Primary Opportunities (0960698) fund, will look at an overhang as part of the process when selecting stocks.

He says that it may allow for a ‘double discount’ as along with the discount associated getting in at IPO, if there’s a major shareholder selling out their stake this may also create an attractive buying opportunity.

RBS AN OBVIOUS EXAMPLE

An obvious example of a share overhang would be Royal Bank of Scotland (RBS). The Government still has a 62.4% stake in the bank after bailing it out in 2008.

When £2.6bn worth of these shares were sold in the latest tranche in June 2018 (4 Jun) the share price hit a downward spiral.

On the day the shares were sold, they lost 3.5% of their value but with the chancellor Philip Hammond signalling his intent to sell down the stake further, this spooked the market and the price continued to drop.

As Brown notes there are other reasons that banks in general may be losing investor appeal such as the potential impact of Brexit and low interest rates which limits their profitability.

RBS has made something of a recovery, having not made a profit for ten years and recently resumed dividends but the share overhang looks likely to remain a risk for investors to weigh for the foreseeable future.

THE ROLE PLAYED BY INDIVIDUALS

Julian Dunkerton, the co-founder of retail brand Superdry (SDRY), recently sold £71m of its holding in his company after selling a 1.23% stake for £17.8m a few months previously. Should investors be worried that the person who was instrumental in the development of the business has decided he doesn’t want to be involved anymore?

Brown, who has held Superdry at one point, was considering whether to buy back into the company. He says this type of overhang is fine as long as investors are comfortable with the reasons why the founder is selling up.

Others such as Mark Dixon, founder of serviced office company IWG (IWG), are serial sellers of large swathes of shares. One issue when big stakes are sold of intermittently is that it will cause share price volatility.

If an investor is a holder of a company which suddenly looks like selling large stakes in the company it may not be the
best news in terms of impact on share price.

Alternatively, if an investor is looking at an entry point to a company, a large share overhang may be good news if it leads to some short-term weakness in the share price. Once the market has digested the available shares, chances are that the price may start its upward descent again.

However, while share overhangs can be an issue for a variety of reasons, there are by no means the first thing to consider when looking at a stock.

FOCUS ON FUNDAMENTALS

Regardless of whether a business has a large overhang over it or not, it has to be a good business to consider investing.

As Brown says, ‘valuations trump overhangs’ every time. (DS)

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