A reverse stock split is an action taken by a company that consolidates existing shares in order to increase price per share.
This is usually done by dividing the total number of shares by a certain number like five (1-for-5 reverse split) or ten (1-for-10 reverse split).
Reverse stock splits are also known as a stock merges, stock consolidations, or share rollbacks and are the opposite of stock splits.
How Does a Reverse Stock Split Work?
An example of a reverse stock split is the 1-for-10 reverse stock split announced on March 9, 2022 by Altan Nevada Minerals Ltd.
The total issued common shares as of September 2021 was 13,929,089.
A 1-for-10 stock split reduced the amount of issued common shares to 1,392,909.
Reverse stock splits usually happen when a company wants to change its capital structure.
The existing shares are merged to create a smaller pool of shares, but they are proportionally more valuable to retain the value of the company as a whole.
In this case, investors who held shares of the company would have seen the number of shares in their account drop, but the total value of their shares remain the same.
Why Do Companies Reverse Split Their Stock?
The primary reason companies decide to do reverse stock splits is to raise the price per share.
Despite raising the per share price, the company’s value does not increase because of the reduced share count.
It’s usually triggered if the company’s per share value is dropping significantly and generally has a negative connotation.
Did You Know?
To remain listed on the NASDAQ exchange, a company needs to maintain a share value of over $1.00.
Advantages of Reverse Stock Splits
Remain on Exchanges
If a company’s share price drops below a certain amount, it will be in danger of being removed from a major exchange since it would fail to fulfill the listing requirements.
Generally, a major exchange like the NYSE will have a minimum share price, and if a company’s per share price drops below it for an allotted time, it may be delisted.
Higher per share price can put a company in a position where their share price rises above the minimum value that mutual funds or other institutional investors require to invest.
Raise Spinoff Share Value
Sometimes, companies will spin off operations, which occurs when an existing parent company sells or distributes its shares to create an independent company.
Boosting the spinoff share price may make the new company a more attractive investment opportunity.
Depending on the area of operation and the jurisdiction rules where the company operates, the number of shareholders determine how it will be regulated.
With fewer shareholders, a company may fall under a more beneficial set of regulations.
Reducing shareholders is also a move that companies make when they aim is to go private.
Disadvantages of Reverse Stock Splits
Companies with a stock value that has tanked will sometimes try to artificially inflate the stock price by doing a reverse stock split.
This action could be viewed by investors as one of a struggling company, making it a less attractive investment.
Loss of Liquidity
Since a reverse stock split reduces the overall number of shares, undergoing this process reduces a company’s liquidity.
Loss of liquidity can eventually lead to a fall in share price, canceling out the original reverse stock split.
Impact on Investor Morale
For the most part, investors won’t want to see the amount of shares they own in a company decrease, regardless of whether the value stays the same.
They may decide to liquidate their shares which could impact the share price negatively if enough investors sell.
Who Benefits From a Reverse Stock Split?
The company performing the reverse stock split receives the main benefit.
It can stabilize the company if their financial situation and stock price are facing a crisis.
It also makes the company more appealing to investors and can save it from being delisted from major exchanges if it’s in an at-risk position due to its share price.
Usually, it’s a telltale sign that the company isn’t doing well, but it’s not always a sign that the company will fail.
Frequently Asked Questions
- Is a reverse stock split good?
Companies that consider and/or carry out reverse stock splits are generally not in a good position. If the split is accompanied by drastic action to right the ship, it could be beneficial for the company and shareholders. If those changes improve operations and profitability, the company and its shareholders will benefit from the higher price.
- What is a 1-for-10 reverse stock split?
A 1-for-10 reverse stock split means that the shares will be consolidated at a 1:10 ratio. Every ten shares will be combined into one share with equal value to those ten shares. For example, a company has 1,000 shares in circulation valued at $1,000 ($1 per share) and decides to do a 1-for-10 reverse stock split. After the reverse stock split, the company now has 100 shares in circulation still valued at $1,000, but each share is now worth $10.