A reverse stock split references an event wherein a company reduces the number of outstanding shares of its stock and increases the stock’s face value, thus maintaining the company’s overall market capitalization. It is the opposite of a forward stock split, which increases the number of allocated shares, though the face value per shares is lower. This process is most often seen in companies engaging in capital restructuring, for instance to reduce the size of the issued capital.
The primary purpose of a reverse stock split is to manipulate the stock’s price, by reducing the number of shares and increasing the face value of those shares accordingly. This process has direct implications on the company’s stock market that, depending on the firm’s particular structure, can be positive or otherwise. This is strongly linked to the firm’s investor base which may, for instance, exhibit more interest and activity in stocks priced high.
The process of reverse stock splitting often aims to boost stock prices, most notably by compensation committees in publicly traded companies. This maneuver is popular mostly among such companies with a diminished market capitalization. In a rare situation this could be a strategic decision made to increase share value, as a result of an insufficient voting-power in the hands of the Board of Directors.
The effects of a reverse stock split can be summarized as follows: a decrease in the number of allocated outstanding share and an increase in their respective face value. Following a reverse split, the company’s total market capitalization will remain unchanged. This process has direct implications both on the company’s stock market capitalization and the activity and interest of investors.
The most prominent consequence of a reverse stock split regards the market activity of a company’s stock. Evaluation of a reverse stock split does not necessarily reflect upon the intrinsic value of a company and the shares, but it does become an attractive option for those looking to buy a fraction of a company. Arguably, professional and institutional investors will avoid a stock for their portfolio because of its low face value, thus a reverse stock split may be the only way for a stock to garner any interest.
In effect, a reverse stock split is a signal to the market that there is still considerable promise in a stock, given the above-mentioned increase in its face value, and the signal is well received by investors. The manipulation in the stock’s price usually results in an increase in trading activity and a higher liquidity, both of which can impact a company’s overall market capitalization.
Largely dependent on the size of the split, a reverse stock split may tremendously reduce the administrative burden of managing a large number of shareholders. Subsequent to the split, share certificates must be ammended and shareholders must be notified designated, which is a much more accessible and quickest process given the fewer number of shares.
On the contrary, a company may also face a number of optional costs associated with a reverse stock split, like the additional cost of shareholder communications, a repeal of tax benefit rights or incentives, to name a few. In a fraction of cases companies may also decide to issue a special dividend to shareholders is order to offset the cost of the split. Such cases are however very rare and are usually excluded from the final plan.
Investors of the stock impacted by the reverse split still retain the same number of shares as pre-split, with the only difference being an increased face value. The rationale behind this is quite simple: A 200:1 reverse stock split means that every two hundred shares of a company’s stock are reduced to a single share of stock with a considerably higher face value. This works best for investors who view stocks as long-term investments rather than short-term vehicles for capital gains.
In the case of a vote on a reverse stock split, shareholders may expect the right to vote on the proposed reverse split and its implications. If the split is approved, it could bring invaluable benefits to a company’s shareholders, like the opportunity to trade a stock with a higher face value or to be seen as an attractive option in the eyes of institutional investors.
Risks of a Reverse Split
Counterintuitively, a reverse stock split can actually have a negative impact both on a company’s stock and shareholders, in cases where this procedure results in a gaming of the market. If investors perceive it as only a temporarily bump in the company’s stock market performance, this maneuver could backfire and the investor sentiment surrounding the stock could be damaged for the short and long term prospects of the company.
Moreover, this process could significantly reduce the cumulative voting power shareholders held before the reverse split. This could leave current shareholders virtually powerless when it comes to decisions related to corporate governance, as liquidation events, mergers and more. Such decisions could be made when investors are outnumbered and left to bear consequences of decisions made by the minority, who might hold disproportionate control of the company.
Different jurisdictions maintain different rules and regulations, apart from any relevant shareholder voting on the matter. It is important for companies to inform the respective government or regulator prior to the implementation of the stock split. This can take a significant amount of time, and companies must abide by the regulations that such government may choose to impose.
In jurisdictions like the US, reverse stock splits are most often carried out under the oversight of the Securities and Exchange Commission. This body may require a number of filings from the company, over an extended period of time, due to the magnitude of the split and its possible effects on stock market capitalization and investor behavior.
It is crucial for companies to consider all relevant implications that such a complex and heavily regulated process entails. The sheer complexity should not be overlooked: a successful reverse stock split may be able to give a much-needed boost, but it also stands to cause considerable administrative and financial burden. The majority of companies in an effort to avoid earnings dilution, are involved in such an event, but whether it is the right decision or not, depends on the company’s current setup, their investor base and the likely effect on market volatility in mind.
In essence, a reverse stock split should be considered a viable solution, carefully evaluated in terms of the business’ current and long-term prospects, profitability and its present status with regards to the respective regulator. Due to its high complexity, a number of firms often seek the assistance of firms specializing in such transactions, in an effort to identify any potential risks and mitigate such risks prior to any filing.
Reverse stock splits are becoming increasingly commonplace among large public companies all over the world, as the dynamics of financial markets and investor behavior continue to evolve. The option of a reverse split is now often exercised by companies looking to raise their stock market value, albeit the process is still heavily occurred with risk. With markets becoming more and more volatile, thorough analysis and strategic planning are necessary for companies to judge whether a reverse stock split is the right avenue for them.
Recent technology trends like data-driven decision-making and computer-based trading may enable companies to accurately gauge the prospect of a reverse split and its possible effects; such technology however remains exclusive to advanced investors and larger funds. As a result, smaller shareholders will continue to rely on their own research and the company’s filings regarding the transaction, while larger investors attract a greater degree of certainty thanks to the increasing prevalence of robotics.
Since the procedure of a reverse stock split generally works to artificially inflate a company’s market capitalization, certain international regulations prohibit the conduct of such transactions. This reflects the nature of a reverse split, a situation wherein a firm’s market value is not based on an organic increase in stock prices, but instead on measures taken to manipulate the stock’s price. These sorts of regulations include the European Union’s Market Abuse Regulation, which a company must consider if it has substantial operations or a wider investor base spread over its jurisdictional boundaries.
The implementation of such regulations is reflective of the industry’s struggle with market volatility, as well as a move towards greater transparency and corporate governance. Examples of international oversight include real-time reporting processes or pre-announcement clearance of a reverse split, depending on the particular regulator’s stance. Those considering this procedure must also take into account updating their public filings and/or external publications in accordance with such regulations.
Despite being commonly seen as a measure to raise capital, a reverse stock split does not typically lead to an influx of funds in a company’s coffers. Companies that intend to raise capital from the market can opt for other measures, like issuing bonds or diluting the stock’s capital structure. Companies must be aware, that the process of reverse stock splitting requires significant financial resources and should be considered a necessary emergency measure.
Moreover, in some cases current and long-term shareholders may be subject to additional taxes and compliance costs, mainly depending on the jurisdiction of the transaction. These additional expenses should be taken into account prior to implementing the reverse stock split, in order to accurately gauge their revenue prospects both in the short term and the following quarters.