Reverse stock splits have been likened to that last cigarette before the firing squad -- they buy a little more time until the bullet arrives. By decreasing the number of shares in circulation, thus increasing the price of each share, a reverse split can give a penny stock the veneer of price legitimacy -- at least for a while. Traditionally, the tactic has been used by ailing microcap companies whose shares have fallen so low that they either scare off investors, face delisting or both.
It’s hardly a shock, then, that reverse splits have been on the rise over the past several years, as hundreds of companies that went public during the boom of the late 1990s crashed and burned. According to Goldman, Sachs & Co., 84 companies completed reverse splits last year. That’s down from 112 in 2001, but more than double the 38 reverse splits seen as recently as 1996. Indeed, between 1993 and 1997 there were an average of roughly 36 reverse splits per year. But the five years from 1998 to 2002 averaged almost 83 per year. Prebubble microcap stocks stumbled first.
Eighty-four percent of the reverse splits since 1993 have been by companies that were valued at less than $100 million at the time of the split. In many cases, the last-ditch action failed: 196 of these 540 companies -- 36 percent -- either were delisted or ceased to be public companies.
“The vast majority end up in the category of facing delisting,” says Ingrid Tierens, one of the Goldman analysts who has researched reverse splits. “So there appears to be a negative signaling effect to doing a reverse stock split.” For that reason the firm advises its investing clients to reduce their exposure to or short the shares of companies that complete reverse splits.
Within the past year, however, some large companies -- including AT&T Corp., its former subsidiary Lucent Technologies and handheld-organizer maker Palm -- have either completed or approved plans to proceed with reverse splits. To be sure, these firms have their troubles, but they likely aren’t going under. These companies prompt debate that reverse splits can help engender turnarounds rather than simply providing a leaky life preserver for the drowning.
“It’s definitely a legitimate tool,” says James Rossman, head of the equity solutions group at Lehman Brothers. “But because it has historically been such a signal of distress, people usually wait to do it around some other transitional event, so it can be in combination with a positive event for the company.”
For example, in November AT&T executed a one-for-five reverse split, concurrent with the sale of its AT&T Broadband cable division to Comcast Corp. Shareholders received the spin-off warmly because it freed the faster-growing cable business from AT&T’s more mature, money-losing long-distance business, garnering a higher valuation as part of Comcast.
Before these moves, investors and analysts valued AT&T’s noncable operations at $5 to $6 per share. The reverse split cut the number of shares outstanding after years of stock-financed acquisitions and erased the stigma often attached to low-single-digit stocks.
“Just for optics’ sake, it doesn’t make a lot of sense for AT&T to be a $2 or $3 stock,” says Richard Sullivan, AT&T’s head of investor relations.
Since then, however, the split shares have declined almost 50 percent -- from 27 to 14. Palm initially rallied as well, but is now down 10 percent since its one-for-20 split October 15. According to Goldman, in the 40 days after a reverse split, stocks underperform the broader market by more than 15 percent on average.
Some think that a new wave of reverse splits may not materialize until companies that seem poised to survive the extended fallout from the dot-com and telecommunications crashes are confident that their business has turned around. At that point, the reasoning goes, these companies will be able to execute a split while also highlighting their improving fundamentals. If that happens, reverse stock splits may no longer seem like a momentary stay of execution.
