 Personal Finance PowerPoint Presentation, reverse stock split. Prepare to get financially fit by practicing personal finance. Most of this information is from Investopedia, reverse stock split, which you can find online. Take a look at the references, resources, continue your research from there. This by Akalash Ganti updated July 11th, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools, keeping in mind the two major categories of investments. Fixed income, typically bonds, equities, typically stocks. We're looking at the stock side of things here. Quick recap of what stocks are. Remember that corporations are a separate legal entity. Stock representing ownership in the corporation, each stock representing an equal type of ownership investment for each individual stock, making them easier to trade and value than the corporation may go public, meaning it can be traded on a public exchange, making it easier for investors to be investing in a corporation. So typically when we're talking about valuing stocks, we're usually talking about publicly traded corporations. Keeping that in mind, we're now looking at what is a reverse stock split. So a reverse stock split is a type of corporate action that consolidates the number of existing shares of stock into fewer higher priced shares. So this is a little bit less common or a lot less common to do in action than a stock split, meaning a stock split is usually taking the number of shares that are outstanding and splitting them, oftentimes doubling them, but we could use other ratios as well. A reverse stock split is reversing that process, having fewer shares outstanding. So the general idea just to recap this, remember that stocks represent ownership in the company. If we think about the balance sheet of a company, we have assets, liabilities, equity, assets minus liabilities, what the company has minus what they owe to a third party represents the equity interest, kind of like the book value, which you would think then the stock price would be based upon, to some degree, the value of the company. And we can think about that valuation and being represented in the different or the multiple shares that are outstanding. So if you were to then double the number of shares that are outstanding, this would be a stock split as opposed to a reverse stock split, that would mean that you would have twice as many shares outstanding, but they would still be representing the same valuation to the company because there had not been any underlying change to the company value. In other words, in that instance, the company didn't issue new stocks and therefore didn't get cash increasing the equity in the company. And that a stock split, they just have the same balance sheet with twice as many stocks. So therefore you would think that you would have twice as many stocks out there, but they would be worth half as much. A reverse stock split is basically the opposite. So now once again, you're not doing anything on the balance sheet side of things. You're just gonna say that each stock is now worth some multiple less than it was before so that now you have the same valuation on the company, but there's less stocks representing that value of the company. Okay, so let's go into more detail. A reverse stock split divides the existing total quantity of shares by a number such as five or 10, which would then be called a one for five or one for 10 reverse split respectively. A reverse stock split is also known as stock consolidation, stock merge or share rollback. And is the opposite of a stock split where a share is divided split into multiple parts. Understanding reverse stock split, depending on market developments and situations, companies can take several actions at the corporate level that may impact their capital structure. One of these is a reverse stock split whereby existing shares of a corporate stock are effectively merged to create a smaller number of proportionately more valuable shares. So meaning there were more shares out there of a lower value. You're gonna basically make lesser shares out there, not changing the underlying value of the company. Therefore, you would expect those lesser shares to be of higher value on the market, although it could be a negative indicator on the market as well and could affect the price. So since companies don't create any value by decreasing the number of shares, the price per share increases proportionately. So per share price bumping is the primary reason why companies opt for reverse splits and the associated ratio may range from one for two, two as high as one for 100. In other words, when you look at a stock split, a normal kind of stock split, oftentimes that happens when the stock price is getting too high outside the range to the company saying, hey, let's do a stock split so that we get the range into the ballpark that might drive more people to want those particular stocks because it's in the range they're used to, for example, if the price becomes too low, possibly even to the point where they're gonna get kicked off of the exchange, which would be bad, then you might do the reverse stock split in essence trying to increase the price of the individual stocks to somewhere that would be appropriate, either for just the perception of the stock itself or possibly to get it above a threshold level to not be in danger of being kicked off the exchange. So reverse stock splits do not impact a corporation's value, although they are usually a result of its stock having shed substantial value. So normally you don't plan for a reverse stock split. I mean, you would like the company to be going up in value and then have to deal with the question as to whether you wanna do a normal stock split. You don't want the price going down and then have to choose whether or not you have to do a reverse stock split. So it's usually a negative indicator to the market if you're in that position. So the negative connotation associated with such an act is often self-defeating as the stock is subject to renewed selling pressure. So advantages and disadvantages of reverse stock split, there are several reasons why a company may decide to reduce its number of outstanding shares in the market, some of which are advantageous, advantages, prevent major exchange removal. So a share price may have tumbled to a record low levels which might make it vulnerable to further market pressure and other outward developments such as failure to fulfill the exchange listing requirements. In other words, to be on the exchange, there's requirements such as keeping your stock price of above a certain level. So if you're in danger of going below that, then that's not good. You might be kicked off the exchange and not have access to the capital that would typically be there if you're on exchange. So an exchange generally specifies a minimum bid price for a stock to be listed. If the stock falls below this bid price and remains lower than that threshold level over a certain period, it risks being delisted from the exchange. For example, NASDAQ may delist a stock that is consistently trading below $1 per share. Removal from a national level exchange relegates the company's shares to penny stock status, forcing them to list on the pink sheets. So they're not on the exchange, they're on the pink sheets. And so there's a lot less kind of regulatory scrutiny there. So it's not as, so people investing there then are gonna need to do a lot more kind of their homework and so on. Whereas if they're on the exchange, people typically have more trust in the companies on the exchanges because they have to jump through the regulatory hoops and whatnot at there. So you don't usually, of course, want to be kicked off the exchange to the pink sheets. So what's placed on these alternative marketplaces, the low value stocks, the shares become harder to buy and sell. So if they can't buy and sell the shares then the company has less capacity to generate capital money in essence to grow. So attractive bid investors. So companies also maintain higher share price through reverse stock splits because many institutional investors and mutual funds have policies against taking positions in a stock price is below a minimum level. In other words, even if it's not so low they're gonna get kicked off the exchange, they're trying to make the big institutional investors happy. So if the big institutional investors like some minimum level of price for their own policies then you're trying to make them happy because that's where the capital is. So even if a company remains free of delisting risk by exchange it's failure to qualify for purchase by such a large size investors Mars is trading liquidity and reputation satisfy regulators. In different jurisdictions across the globe a company's regulation depends upon the number of shareholders among other factors. So how many, the number of shareholders you wanna comply with the regulatory factors so that you have the capacity to do business and or be on exchanges whatever the regulatory rules are allowing you to comply with or do. So by reducing the number of shares companies at times aim to lower the number of shareholders to come under the purview of their preferred regulator or preferred set of laws. Companies that want to go private may also attempt to reduce the number of shareholders through such measures. So if they're on a public exchange and they're saying, hey, look, we don't want to be a public company we would like to take it back to a private company possibly because at that point you don't have to deal with so much of the regulatory burdens and so on. And in some cases it might be more beneficial than you might choose a strategy in order to do so. Boost spin-off prices. Companies planning to create and float a spin-off an independent company structured through the sale or distribution of new shares of an existing business or division of a parent company might also use reverse splits to gain attractive prices. So in other words, you might have a large business a long time ago or not too long ago but there was a trend to try to conglomerate everything because the thought was that everything was like a business of scale or an economy of scale bigger was better was the idea. And so you saw these companies and they also thought that management of any good management can manage anything. So they tried to pull all these different things together and then later on it kind of people kind of realized that, well, that doesn't work for everything not everything is an economy of scale. So maybe it would be better for certain companies that are big conglomerates, for example, to spin-off things that aren't in their specialty area. And so then you've got this spin-off meaning you want to make another company that's gonna specialize in this one particular area and so you might use strategies to do that. For example, if shares of a company planning to spin are trading at lower levels, it may be difficult for it to price its spin-off company shares at a higher price. So the issue could potentially be remedied by reverse splitting the shares and increasing how much each of their shares trades for. Disadvantages, generally a reverse stock split is not perceived positively by market participants. So clearly when you see a reverse stock split that's like, well, that's going the opposite way of what people would like to see. What they'd like to see is a nice upward trend. Price is going up and then they had to do a stock split because the price got too high. So unless there's some kind of strategic plan like a spin-off or some other strategy that they're trying to do, it's gonna generally have a negative impact on the perception because it's signaling some kind of problem if there's no reason for it. And that problem would be, well, the price seems to be getting too low. Maybe they're worrying about not complying with some kind of regulation or being kipped off the exchange or not being able to trade with the big players in the market, which is a bad sign. So it indicates that the stock price has gone to the bottom and that the company management is attempting to inflate the prices artificially without any real business proposition. Additionally, the liquidity of the stock may also take a toll with the number of shares getting reduced in the open market. Example of a reverse stock split, say a pharmaceutical company has 10 million outstanding shares in the market which are trading for $5 per share at the share price is lower, the company management may wish to artificially inflate the per share price. So they say $5 is getting pretty low. We wanna make it higher. So how are we gonna get higher? Well, we need less shares out there to make each share more. So they decide to go for a one for five reverse stock split which essentially means merging five existing shares into one new share. Once the corporate action exercise is over, the company will have 2 million new shares, 5 million divided by five, which each share now costs $25 each rather than the $5 each. So now they got more shares out there, the share price at the 25, which is kind of more of what they're thinking is that sweet spot, whereas the $5 per shares looking a little low. So again, that $25 does look better clearly, but the fact that they did a reverse stock split is a bad signal. So that's kind of the idea. So the proportionate change in share price also supports the fact that the company has not created any real value simply by performing the reverse stock split, meaning they didn't change the balance sheet at all. There's no underlying valuation that changed. They just changed the number of stocks that are out there. In other words, assets minus liabilities equals equity still the same. So it's overall value represented by market capitalization before and after the corporate action should remain the same. The previous market cap is the earlier number of total shares times the earlier price per share, which is 50 million. So five times 10 million. The market cap following the stock merger is the new number of total shares times the new price per share, which is also 50 million, which is 25 times 2 million. So real world example, in 2002, the largest telecommunications company in the United States, AT&T with the ticker sign T, performed a one for five reverse stock split in conjunction with plans of spinning off its cable TV division and merging it with Comcast Corp CMCSA. So they kind of have a strategic plan. AT&T clearly a big company, so they're not endangered necessarily of getting kicked off the exchange or anything like that, but they're trying to spin off here. So they have a strategy in place. So the corporation, the corporate action was planned as AT&T feared that the spin off could lead to a significant decline in its share price and could impact liquidity, business and its ability to raise capital. Other regular instances of reverse stock splits include many small, often non profitable companies involved in research and development. That's the R&D, which do not have any profit making or marketable product or service. In such cases, companies undergo this corporate action simply to maintain their listing on a premier stock exchange. Why would a company undergo a reverse stock split? Reverse splits are usually done when the share price falls too low, putting it at risk for delisting from an exchange for not meeting certain minimum price requirements. Having a higher share price can also attract certain investors who would not consider penny stocks for their portfolios. What happens if I own shares that undergo a reverse stock split? With a reverse stock split, shareholders of record will see the number of shares they own be reduced, but also see the price of each share increase in a comparable manner. For instance, in a one for 10, one colon 10 reverse stock split, if you own 1,000 shares that were trading at $5 just before the split, you would then own 100 shares at $50 each. So in other words, if I'm the owner of the shares, the idea would be that I'm not changing the value of my ownership. It's just now that I have more shares which have been adjusted upward in terms of the amount per share. So then your broker would handle this automatically so there's nothing you would need to do. So in your end, if you were holding the shares, this would be decided by the company, brokered handling the transaction. You don't need to do anything. A reverse split will not affect your taxes. In other words, it's not a taxable event. Taxable event usually happens when you sell the stock realizing some kind of gain or loss and no action has taken in terms of selling it. So a reverse split, good or bad? Is it good or bad? Many times, reverse splits are viewed negatively as they signal that a company's share price has declined significantly, possibly putting it at risk of being delisted. So as a market signal, it's gonna be perceived oftentimes as not good. The higher price shares following the split may also be less attractive to certain retail investors who prefer stocks with lower sticker prices. Why does the ETN I own have so many reverse splits? Some exchange traded products like exchange traded notes, those of the ETNs naturally decay in value over time and must undergo reverse splits regularly. But these products are not intended to be held for longer than a few hours or days. So it's kind of a specialized area here. This is because ETNs are technically debt instruments that hold derivatives on products like commodities or validity linked instruments and not the actual underlying assets.