The three most important reasons for investors why companies do reverse splits are (1) to maintain listing on an exchange, (2) to make the company’s shares marginable, and (3) to attract institutional investors.
To maintain listing on an exchange
A large majority of reverse stock splits are done by Nasdaq listed stocks that have very low prices. Among other requirements for an initial listing on the Nasdaq, a company must have a share price of at least $4. If a company’s share price then falls below $1, the company is in danger of being delisted from the Nasdaq. So a company that is contemplating a reverse split for the purpose of maintaining a Nasdaq listing has likely already seen its share price drop from at least $4 a share to under $1 a share. Keeping in mind that a reverse split does nothing to change the fundamentals of a company doing one, an investor should not expect that a listed company that has seen its share price fall at east 75% should suddenly see a turn around after a reverse split. On the contrary, absent some other indicator, the investor should expect the decline to continue unabated.
To make the company’s shares marginable
The Federal Reserve Board’s Regulation T sets the minimum price at which a stock can be margined at $2.00. If the share price of a stock is below $2.00 a share then the stock cannot be bought on margin. Therefore, of the potential pool of investors in a particular stock, those who are purchasing on margin are precluded from buying the stock. So if a reverse split results in a share price above $2.00, the company in question has added margin buyers to the company’s pool of potential investors. Adding potential investors to a company’s pool of investors, in and of itself, is a positive for existing investors and possible future investors because it adds liquidity to the market for the company’s shares.
To attract institutional investors
Many institutions have minimum thresholds for the share price of stocks in which they will invest. If the share price is below the minimum threshold the institution will not invest in the company. Typically, the minimum threshold is between $5.00 and $10.00 a share. If a company has a share price of $2.00 and an institution has a minimum share price threshold of $5.00, the institution will not purchase shares of that company. Therefore, all other things being equal, if a reverse split increases the company’s share price above the institutions’ minimum thresholds then the company doing the reverse split has added institutional investors to its pool of potential investors. And just like adding margin buyers to a company’s pool of potential investors, adding institutional investors to a company’s pool of investors, in and of itself, is a positive for existing investors and possible future investors because it adds liquidity to the market for the company’s shares.
How should investors view a reverse stock split?
The first thing any investor should do when confronted with a reverse split is think, and not simply react. Conventional wisdom, that reverse spits are bad, may be correct in the majority of cases but it is not inevitably correct. If the directors of a company listed on an exchange have seen the share price precipitously drop, to the point that the company is at the risk of being delisted, and the directors do a reverse split and nothing else to forestall delisting, then there is a very good probability that the post-reverse share price will continue to decline.
On the other hand, if a company is not listed or not in danger of being delisted and is doing a reverse split to expand its pool of potential investors, then the reverse split may well be a positive sign for investors. Investors in a company trading well below the listing, margin, and institutional investor thresholds may well be rewarded by a reverse split because it can add investors to the company’s pool of potential investors, thus increasing share price and investor liquidity.
A well written post displaying things in a proper and balanced. The company currently in good momentum with a series of positive triggers. Management aiming high and want to join the big leagues as soon as possible. Imperturbable investors who can see a few months ahead, should take advantage of the decline to add more. Significant rewards in a few months.
That's what I'm gonna do!
Just read what happened to SRPT
Sarepta Therapeutics Explodes Again: A Short-Seller's Worst Nightmare
Oct 4 2012, 19:56 | about: SRPT (S.A)
Earlier in the year, shares of a little company called AVI BioPharma struggled to even break $1.00/share on open NASDAQ trading, and they actually got de-listed. After a 1:6 reverse stock split (six shares added up into one) and a name change to Sarepta Therapeutics (SRPT), they were back on the NASDAQ at a healthier-looking level. Here's the amazing part -- in less than three months, the stock proceeded to rally 990% to bring the company to a market cap of $1 billion.
In my 40 years market experience I'll tell you what I have seen happen.
RS and mgmt continues to hand themselves so many shares over years without creating the company value to go along with it. Eventually leading to BK.
Then I've also seen them do offerings to take advantage of higher price.
Rarely does a RS suck in allot of new inst. investors or their dollars.
Expect a fall in price and then it will just sit there waiting for pipeline news.