What is a reverse stock split?
A reverse stock split is one typecorporate actionwhereby the number of existing shares is combined into fewer (higher) shares. A reverse stock split divides the existing total number of shares by a number such as five or 10, which would then be called a 1-for-5 or 1-for-10 reverse split, respectively. A reverse stock split is also known as a stock consolidation, stock merger or stock reversal and is the opposite of astock split, where a share is divided (divided) into several parts.
Key learning points
- A reverse stock split consolidates the number of existing shares that shareholders own into fewer shares.
- A reverse stock split has no direct impact on a company's value (only its stock price).
- It can signal a company in distress because it increases the value of otherwise low-priced shares.
- Staying relevant and avoiding delisting are the most common reasons why companies adopt this strategy.
:max_bytes(150000):strip_icc()/Term-r-reverse-stock-split-Final-d87a97b081a64a98aa6c2064cfac6e68.jpg "Reverse Stock Split: What It Is, How It Works and Examples (1)")
Understanding Reverse Stock Splits
Depending on market development and the situation, companies can take different actions at the corporate level that may influence their situationCapital structure. One of these is a reverse stock split, which effectively combines existing company shares to create a smaller number of proportionately more valuable shares. Because companies do not create value by reducing the number of shares, the price per share increases. share proportionately.
Price per share is the main reason why companies choose reverse stock splits, and the associated ratios can range from 1 to 2 to as high as 1 to 100. Reverse stock splits do not affect a company'svalue, although they usually result from the shares having fallen significantly in value. The negative connotation associated with such actions is often self-defeating as the stock is subject to renewed selling pressure.
A reverse stock split is proposed by the company's management and is subject to the approval ofshareholdersby themto vote.
Pros and cons of reverse stock split
There isseveral reasons whya company may decide to reduce the number of shares outstanding in the market, some of which are beneficial.
Benefit
Avoid major removal of compromises:A stock price may have fallen to a record low, making it vulnerable to further market pressure and other adverse developments, such as stock market defaultslisting requirements.
An exchange typically specifies a minimumbid priceto list a share. If the stock falls below this offer price and remains below this threshold level for a certain period of time, there is a risk that it will be delisted from the stock exchange.
For example, Nasdaq may delist a stock that consistently trades below $1 per share. stock.By delisting from a national stock exchange, the company's shares are given penny stock status, forcing them to list onpink platesOnce placed on these alternative markets for low-value stocks, the stocks become more difficult to buy and sell.
Attract big investors: Companies also maintain higher stock prices through reverse stock splitsinstitutional investorsand investment funds have policies against taking positions in stocks whose price is below a minimum value. Even if a company remains free from the risk of delisting, a company's inability to qualify for purchase by such large investors destroys its trading business. liquidityand reputation.
Satisfying regulators: In various jurisdictions around the world, the regulation of a company depends, among other things, on the number of shareholders. By means ofreduce the number of shares, companies sometimes seek to reduce the number of shareholders to fall under their preferred regulator or preferred legislation. Companies that want thatga privatecan also try to reduce the number of shareholders through such measures.
Increase spin-off prices: Companies that plan to create aspin-off, an independent company that is built up by selling or distributing new shares in an existing company or by splitting off aparent company, can also use reverse splits to achieve attractive prices.
For example, if the stock of a company planning a spin-off is trading at a lower level, it may be difficult to price the spin-off company's stock at a higher price. This problem could potentially be addressed by reverse splitting the shares and increasing the amount each of their shares trade for.
Cons
In general, a reverse stock split is not viewed positively by market participants. This indicates that the stock price has bottomed out and the company's management is trying to artificially inflate prices without any real business proposition. Additionally, the stock's liquidity can also take a toll as the number of shares on the open market is reduced.
Example of a reverse stock split
Let's say a pharmaceutical company has 10 million shares on the market, with a trading price of $5 per share. stock. Since the stock price is lower, the company's management may want to artificially inflate the price per share. build up a stock.
It decides to go for the 1-for-5 reverse stock split, which essentially means combining five existing shares into one new share. When the corporate action exercise is over, the company will have two million new shares (10 million/5), with each share now costing $25 each ($5 x 5).
The proportionate change in the stock price also supports that the company has not created any real value by simply executing the reverse stock split. The total value, represented bymarket value, before and after the corporate action must remain the same.
The previous market value is the previous number of total shares times the previous price per share. shares, which is $50 million ($5 x 10 million). The market value after the stock merger is the new number of total shares times the new price per share. shares, which also amounts to $50 million ($25 x 2 million).
The factor by which the company's management decides to proceed with the reverse stock split will be the multiple by which the market automatically adjusts the stock price.
Real world example
In 2002, the largest telecommunications company in the United States, AT&T Inc., launched. (T), conducted a 1-for-5 reverse stock split in connection with plans to spin off its cable TV division and merge it with Comcast Corp. (CMCSA). The corporate action was planned because AT&T feared that the spin-off could lead to a significant decline in its stock price and could affect its liquidity, operations and ability to raise capital.
Other common cases of reverse stock splits include many small, often unprofitable companies involved, which does not have a profitable or marketable product or service. In such cases, companies take this corporate action just to maintain their listing on a premierscholarship.
Why would a company undergo a reverse stock split?
Reverse splits are usually executed when the stock price falls too low, creating a risk that the stock will be delisted from an exchange for not meeting certain minimum price requirements. Having a higher stock price can also attract certain investors who wouldn't consider penny stocks in their portfolio.
What happens if I own stocks that undergo a reverse stock split?
In a reverse split, shareholders will see the number of shares they own decrease, but also see the price of each share increase in a similar manner. For example, in a 1:10 reverse stock split, if you owned 1,000 shares that were trading at $5 just before the split, you would then own 100 shares at $50 each. Your broker will handle this automatically, so you don't have to do anything. A reverse split will not affect your taxes.
Are Reverse Splits Good or Bad?
Often, reverse splits are viewed negatively because they indicate that a company's share price has fallen significantly, potentially putting the company at risk of delisting. The higher prices after the split may also be less attractive to certain retail investors who prefer stocks with lower sticker prices.
Why does the ETN I own have so many reverse splits?
Some exchange traded products such asexchange traded notes (ETNs)naturally decline in value over time and must undergo periodic reverse splitting, but these products are not intended to be kept for more than a few hours or days. This is because ETNs are technically debt instruments that contain derivatives on products such as commodities or volatility-related instruments, and not the actual underlying assets.
In short
When a publicly traded company consolidates shares, it is known as a reverse stock split, or sometimes as a stock consolidation, a stock merger, or a stock flip. The consolidation has no impact on the value of a company. For example, if five million shares trade at $10 per share, a 1-for-5 reverse split would result in one million shares trading at $50 per share. stock. Reverse stock splits are often considered negative because they are often a way to inflate a stock's price without increasing the value of the company.
