Reverse Stock Split May Not Reverse a Company’s Fortunes

They represent the flip side of a stock market boom, a last-ditch attempt some commentators maintain to recapture the glory of a high-flying stock price without the heavy lifting. They are reverse stock splits, or equity markets plays on the law of supply and demand designed to boost stock prices simply by shrinking the number of shares available for public trading. There have been hundreds of them since the technology bubble burst and the stock market tumbled over the last two years. Does the ploy work? Not in the caustic view of several market commentators who tend to regard them more as a mark of shame than an artful price-propping technique. In a recent column on TheStreet.com, James J. Cramer, commented, “The stocks are just so ugly, just such badges of dishonor, that they have to have radical cosmetic uptake.” Financial journalist Michael Brush, writing in a column for MSN Money, advises looking at a reverse split as a “flashing red light warning that you may need to kick a stock out of your portfolio.” Heavy hitters go the reverse split route Hefty volumes of reverse splits explode nearly every time the stock market peaks out and heads downhill. But they rarely have drawn the attention accorded the reverse split parade of the last two years. In the past, the analysis goes, most of the companies that shrank their equity capitalizations were obscure outfits, lightly traded in the backwaters of the unlisted stock market. That hardly defines the 2002 crop studded with such big-timers as AT&T Corp., Lucent Technologies Inc., Nortel Networks Ltd., Palm Inc., and Ethyl Corp. Reverse splits also were done by a block of one-time high-flyers hit hard by the technology and biotech slump, including Razorfish Inc., Commerce One Inc., MicroStrategy Inc., and Cytogen Corp. An apologist for a reverse split could argue that reducing the number of outstanding shares is a wise, albeit radical, move to adjust a company’s equity capitalization for worse-than-expected financial results and a recognition of reduced prospects for the future. But detractors note that the move rarely works as far as a long-term and sustainable boost in the stock price, unless there is some grand plan for shaking up strategy and operations to dramatically improve performance. However, a reverse stock split could provide some benefit by helping pave the way for m&a and restructurings. A company with fewer shares might make a better target than a company with wider a distribution of stock. On the buy side, a company that does get a lift from a reverse split would have a more valuable currency to distribute. Although a strong linkage between reverse splits and m&a has not been firmly established, it is interesting that a number of reverse splits this year have been connected to dealmaking. AT&T, for example, has a 1-for-5 reverse split in the works after it spins off AT&T Broadband and merges it with Comcast Corp. Fewer outstanding shares will fit better with surviving operations, including its wire line telephone business and other communication services. Palm executed a 1-for-20 reverse split in the 580 million shares that were outstanding when the step was authorized by shareholders in October. The company said that the move would clear the way for spinning off its PalmSource Inc. unit. Palm said that the reverse split was aimed at adjusting the company’s capitalization structure to “appropriate levels” and lifting the stock price before PalmSource is spun off. Great timing for eXcelon’s reverse split An unusual postmerger reverse split was executed after MeriStar Hotels & Resorts Inc. was joined with Interstate Hotels Corp. at the end of July. The reverse split enabled the combined company to trim its outstanding shares and rationalize the share exchange ratio. As a result, Interstate holders got 0.92 share in the combined company for each share held and MeriStar holders got one share for every five shares. The combined company was renamed Interstate Hotels & Resorts Inc. eXcelon Corp. executed a 1-for-8 reverse split on October 8. About two weeks later, it agreed to be bought by Progress Software Corp. for $24 million in cash, or $3.19 a share. The purchase price was a 32.4% premium to the eXcelon’s market price of $2.41 one trading day before the deal announcement.