Reverse stock splits: Lipstick on a pig?I think the best scenario for a reverse split is where a company has issued hundreds of millions of shares over the years and wants to consolidate. As an artificial way to bump up share price as studies have shown it usually fails. Citigroup a large corporation which thrives to this day did a 10:1 reverse split in May 2011 and drifted downwards over the next year or so and didn't recover for 2 years. They reinstated their dividend at the same time (albeit minimaI).
I couldn't resist the title of the following article (Lipstick on a pig) so am posting it.
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(Reuters) - Struggling U.S. companies looking to boost their share price with reverse stock splits often wind up making themselves more vulnerable to short sellers, and if the past is a guide, rarely succeed in halting a slide in the post-split share price.
Companies engineering such reverse splits end up not only highlighting a stock's weakness, but the higher per-share price makes it easier and less risky to place short bets, analysts say.
American International Group Inc, a former Dow Jones industrial component, completed a 1-for-20 reverse split at the beginning of July, and options traders immediately started to place bets that the stock would continue to fall. It did -- declining by as much as 59 percent since the split.
"It's just a fact that you're not really fooling anyone with a reverse split," said Paul Hickey at research firm Bespoke Investment Group LLC in Harrison, New York.
"It doesn't change the underlying theme behind the company."
It amounts to dressing the same old investment in makeup to make it look attractive, the proverbial "lipstick on a pig."
Shares tend to underperform in general following reverse splits. For nearly every year since 1980, the median return in the month after reverse stock splits is negative, according to Credit Suisse's equity derivative strategy group.
More reverse splits may be on the way, though, after the carnage of 2008 and early 2009 in equity markets that crushed most stock prices. In mid-March, Citigroup Inc filed a proxy statement with the SEC looking for board approval for a reverse split.
Some think Freddie Mac and Fannie Mae, the troubled government-sponsored mortgage guarantors, could also do reverse splits, as both companies carry share prices of less than $1.
Companies will often do a reverse split to make their stock price appear more attractive to investors, to satisfy certain exchange listing requirements, or to allow the company to be held by institutional investors, who are often prevented from buying stocks that fall below a certain level.
A COSMETIC CHANGE
In a reverse stock split, a company reduces its number of shares outstanding in order to boost the price of each stock. For example, a one-for-two reverse split would leave you with half as many shares, but each would be twice the price.
Rather than owning 10 shares at $10 each, an investor would have 5 shares worth $20 each. Although the price of the stock has increased, the total investment is unchanged.
Companies use the splits to make their stock price appear more attractive to investors who would rather hold a $10 stock than a penny stock.
The practice became common in the early part of the decade after the Internet bubble popped. It peaked in 2002, when more than 100 reverse splits were conducted, according to Credit Suisse, but they have dwindled to just a few per year.
However, the maneuver is more cosmetic than anything else, as the company's market value remains the same, and the fundamental problems that have driven the stock down to begin with have not gone away.
"With AIG, they were trying to avoid being delisted. However, their timing was bad in the sense that they hadn't yet resolved all of the issues at the company," said Charles Lieberman, chief investment officer at Advisors Capital Management in Paramus, New Jersey.
A SIGNAL FOR SHORTS
Conducting a reverse split can also send a signal to the rest of the market that a stock price is unlikely to go up on its own, driving the stock down in the short term.
Short sellers borrow a stock and then sell it with the expectation they will be able to buy it back at a cheaper price, pocketing the difference. A more expensive, more widely owned stock is a better candidate for a short than a $2 stock with little room to fall.
"If a company has had a very difficult time, and its prospects are not improved and in engages in a reverse split, then it will be easier for shorts to operate upon it, and they will step in and increase their positions," said Bill Rhodes of Rhodes Analytics in Boston.
So far, that doesn't appear to be the case with AIG. Shares on loan are roughly the same percentage as before the reverse split, according to analysts at New York-based Data Explorers.
"While a reverse split may make sense down the road, the profitability of the company should be resolved first," said Lieberman. "They should stop losing money and start making money."
(Additional reporting by Caroline Valetkevitch; Editing by Padraic Cassidy)