The stock market is a fast-paced environment. Investors were so enthralled by the technology sector at the beginning of the year, Alphabet Inc., Tesla Inc., and Amazon.com Inc. split their shares to appeal to more retail buyers, often causingtheir stocks to skyrocket.
Hundreds of startups that have seen their shares plummet this year are having to consider the opposite move now, as sentiment toward speculative tech companies is near rock bottom. The reverse stock split allows you to consolidate a large amount of shares into smaller amounts, thereby raising the share price to a level that is less embarrassing.
So far this year, almost 170 Nasdaq Composite Index members have reverse split, according to TradeAlgo, 12 times as many as did a forward split. There is no doubt that more will follow, but investors should be wary: It will not improve the financial fundamentals of these fallen angels, and can worsen a downward spiral.
Despite what you might think, stock prices have symbolic and practical significance, especially in the United States.
A company with a very low stock price may be perceived as low quality by investors. General Electric Co. did a reverse split last year to bring its crumpled share price back in line with its peers in a rare move for a large company.
Institutional investors and mutual funds are often reluctant or prohibited from investing in penny stocks because some brokerages provide no research or recommendations.
Most importantly, listed companies must maintain a minimum share price of one dollar or risk delisting. As a result, the shares would trade on less liquid over-the-counter markets, limiting the company’s ability to raise capital and offer equity incentives.
About 13% of Nasdaq companies trade below a dollar at present. The situation is similar to that of the financial crisis of 2008 and the dotcom bubble of the 1990s.
It’s no surprise that biotech companies are most affected, but there are also a significant number of former special purpose acquisition companies. Since SPACs go public at $10 a share, a 90% drop – regrettably all too common in SPAC-land – puts them at risk of being delisted. All three companies have received non-compliance warnings from their exchanges, including Arrival SA, Bird Global Inc., and Cazoo Group Ltd.
It is common for companies to have a six-month grace period to rectify a too-low share price, and extensions may sometimes be possible. In times of extreme market stress like 2001, 2009 and 2020, exchanges have cut companies even further slack.
A low stock price can be fixed by a takeover, or by reorganizing the company or reducing costs, or by a stock market recovery.
But many of the firms currently languishing below $1 will have to copy NYSE-listed British digital healthcare company Babylon Holdings Ltd., which recently announced a reverse share split to rectify what it describes as its “disastrous” 2021 SPAC listing.
There are others who are looking for a way to avoid the problem. The London-based fintech Paysafe Ltd. wrote to shareholders last week stating that a reverse split would help them “attract, retain and motivate employees, some of whom may be less inclined to work with us if our shares fall below $1.50.”
According to theory, a reverse split should not affect the market capitalization or the value of an investor’s shares. An investor has 1000 shares of one dollar each prior to a 1-for-10 split; afterward, he or she has 100 shares of $10 each. Nothing fundamental has changed.
Sometimes reverse split stocks work out well. With the threat of delisting removed, investors can distinguish between companies with flawed business models and weak financials. In addition, they can distinguish between those whose shares have been caught up in broader market turbulence. Since a reverse split in 2003, Booking Holdings Inc. has gained 7,700%.
As a result, the shares often continue to fall because management is effectively sending a signal that they don’t expect the stock to recover by itself. Short-sellers may also be attracted to reverse splits, resulting in a further reduction in trading volumes and liquidity.
After completing a 1-for-25 reverse split in September, Hippo Holdings Inc.’s share price has fallen 20%, whereas the Nasdaq has increased.
It is common for reverse split firms to go bankrupt, get acquired, or fail to meet listing requirements in the long run. There are many reasons why stock prices are low. Those who ignore that signal do so at their peril.
