A friend recently remarked that looking at the market today is like looking at it three or four years ago, only with everything reversed. What was positive then is negative now; what was up is now down. Perhaps what makes it seem so apocalyptic to my friend and others is the extreme nature of the reversals. Which brings me to the topic of this article: reverse stock splits.
With stocks plummeting to multi-year lows, more and more companies are considering the proposition of bolstering their share prices through a reverse split. The trend is the antithesis of what investors came to expect amid the stock market bubble: prices and shares were supposed to magically expand in value and quantity.
Many of yesterday’s market favorites, names like Nortel Networks, Lucent Technologies, Sun Microsystems and Sonus Networks, are among those rumored to be considering, if not announcing, what traditionally has been seen as a last ditch attempt at survival by companies on the brink of oblivion. Swedish giant Ericsson has already effected one-to-ten reverse split, and Palm a one-to-20 split.
Others have dissected how these household names reached this point, but clearly their prospects have dimmed in the eyes of investors. These are companies whose stock prices have drifted below – or dangerously close to – the dreaded $1 per share, the trigger point for delisting. As they struggle to extract themselves from this predicament, a reverse stock split is fast becoming an immediate answer.
Cosmetic and psychological
The big question is how does the market view a reverse stock split? Most studies have shown that stock prices face pricing pressure after a reverse split, suggesting a lack of enthusiasm on Wall Street’s part.
‘In general it’s more cosmetic, as are regular splits,’ says Scott Sutherland, VP and analyst at Wedbush Morgan Securities. ‘It really comes down to a company executing on a fundamental basis. That’s what is important. Psychologically, a reverse stock split can signal management is not bullish on or confident of their prospects or ability to execute.’
‘As an investor, you’re wondering what other investors are thinking’ adds Paul Cook, director of technology investing at Munder Capital Management. ‘Is there going to be enough liquidity if there are fewer shares?. ‘Can I build a position?’
The psychological impact on investors and the effect on liquidity are key considerations, but tough times call for tough measures. It’s one thing to face delisting or an anemic stock price while the rest of the market is swimming along robustly; it’s quite another when most companies are faltering.
‘Companies like Nortel and Ericsson are billion dollar companies trading in the penny stock range,’ notes Sutherland. Such companies should draw institutional interest, ‘But it’s tough to go out and say you’re a buy at 37 cents. In many cases, investors also get charged on a per share basis on the institutional side, which impacts their trading costs. The reverse split reduces that cost.’
Additionally, many institutional investors have thresholds preventing investment in stocks priced below $5 a share, regardless of market cap. For smaller companies with bleak prospects, a cosmetic move like a reverse split may just prolong the inevitable. But for some stumbling giants, a reverse stock split may be the right remedy today, says Cook.
Cook goes so far as to say that, in some cases, he views a reverse split as a ‘net positive,’ since it increases a company’s chances of finding investors willing to listen to its story. ‘I would counsel companies to consider it if their price has slipped below or near a dollar. You want to make sure you continue to have a stable institutional base to help liquidity. Some think it’s a bad decision, and studies suggest that. But you have to look at it on a company-by-company basis. In some cases, a reverse split is the exclamation point. Long before a reverse split, there are issues that have already come to light.’
If a reverse stock split can be the beginning of a new, better chapter in a company’s history, it must also have a plan to improve the business. That’s true even if it raises the bar well above the $1 threshold by an aggressive reverse split, such as that announced by Nortel in September.
Case studies
Consider the case of MicroStrategy. In March of 2000, its stock traded above $300 per share. What followed was a pre-Enron horror story of accounting fraud that brought the stock price down into the $30 range within weeks. While the company has sought to restore investor confidence, it has been swept up in the economic downturn. By August 2002, its stock was below $0.50. On July 30, 2002, MicroStrategy implemented a one-for-ten reverse split.
‘So far the reaction has been positive,’ says PR director Marc Brailov. ‘Our stock went up significantly. It’s still up from where it was. The Nasdaq $1 requirement was a factor, but it was our belief that the price did not reflect the value of the company. Through the stock price, you can create a more positive perception. We also had significantly more outstanding shares than our competitors, which helped with liquidity.’
MicroStrategy followed up its reverse split with actions aimed at improving its financial picture. The company announced that it would sell off two non-core business assets, as well as other moves to strengthen its financial position. The company still has its critics, but as of mid-October, shares were hovering around $10, well above the $6.75 closing price when the one-for-ten reverse split initially took place.
For Turkish mobile communications operator Turkcell, geographic separation dictated the slightly different tack of a reverse split for its ADR. The IPO was in July 2000, at a price of $17.60. By summer 2001, it had slipped below $1, putting it in jeopardy of NYSE listing requirements. That October, Turkcell altered its ADR-to-ordinary share ratio, from one-to-250 to one-to-2,500, lifting the price to roughly $10. Volatility has since reduced. ‘The stock trades at $12-17, relatively stable compared to going from $17 to $1,’ says IRO Mehmet Sezgin. ‘The trading is more normalized, not because of the split, but because telecoms prices stabilized. The bottom line is we left the danger zone of delisting. We also convinced investors of the value in this company.’
Wisconsin-based Actuant has done more than maintain a steady share price in a difficult market environment. Since the industrial company’s one-for-five reverse stock split on January 25, 2001, its share price has nearly doubled.
Actuant’s situation was slightly more complex than that of many of the companies now considering reverse splits. In July 2000, the company spun off an electronics segment, yet retained the unit’s debt. The surviving entity was half the size of the original company and was trading at roughly $3 a share. ‘We knew a lot of investors don’t want to invest in stocks that low. So we did a one-for-five reverse stock split to move us into the teens,’ says Actuant CFO Andrew Lampereur.
Once the stock price began improving, the company was able to do a follow-on offering. The primary goal was a call-back feature on high yield bonds, but another objective was to increase liquidity. ‘Unfortunately, you can’t really do a follow-on until the stock starts going up after the reverse split,’ says Lampereur. ‘We’d already moved up nearly 50 percent before the follow-on.’
Actuant’s stock price required aggressive communication efforts, especially given the complete makeover of the company. ‘You can imagine, with the turnover, we had to be on the phone non-stop and very visible on Wall Street and at conferences,’ says Lampereur. ‘The key was communication, communication, communication.’
Nasdaq changes the rules
To help some of its ailing tech stocks, Nasdaq instituted a new rule, effective January 2002. Provided it complies with all listing standards aside from the $1 minimum bid price, a company can now ‘phase down’ to the Nasdaq Small Cap market. There, it will have 180 days, and in some cases a further 180 days, to raise its price above $1, versus 90 days on Nasdaq.
Many companies’ securities are now trading below that $1 minimum and are considering moving to the Nasdaq Small Cap Market. The trading is the same, the ticker stays the same, and the corporate governance requirements are the same. ‘You can reapply to the National Market after closing above a $1 for 30 consecutive days,’ says Jocelyn Lynds, IR manager at Sonus Networks. The Massachusetts-based telecom equipment maker is considering a move to the small-cap market or a reverse split because its stock is hovering around the $1 mark (as of November 2002).
