In the investing world, stock splits are usually a good sign, while reverse stock splits are often a sign of trouble. The reasons lie not so much in the acts themselves, but rather what they signal about what preceded them.
Stock splits, in which the share count rises and the price falls by a proportional amount, usually are done to lower the price per share and increase liquidity, which is a move that often happens after a stock's price has gone up. In contrast, reverse splits decrease the share count and increase the stock price. This usually happens after a stock has fallen by a lot. Often, a reverse split is done to stave off a de-listing from the stock exchanges; for instance, if a stock's share price falls below $1.
Thus, should LendingClub (NYSE: LC) investors be worried about its recent reverse split? On July 5, the fintech loan marketplace underwent a 1-for-5 reverse split, decreasing its share count by 80% while boosting its share price from around $3 to roughly $15.
However, here's why I think Lending Club is the rare case in which investors shouldn't panic over a reverse split.
Lending Club executes a reverse-split. Image Source: Getty Images.
No threat of de-listing
One of the most frequent reasons companies choose to execute a reverse split is to avoid de-listing on major exchanges. However, this usually happens when a stock falls below $1 per share. In contrast, LendingClub's stock, even after its precipitous fall from its 2015 IPO, had been rather resilient around the $3 per share mark for the better part of a year.
Additionally, a stock only usually falls that far when a company has a significant amount of debt and bankruptcy is a possibility; however, that's not a concern for LendingClub. In fact, according to the company's recent summer investor presentation, LendingClub has $373 million in cash. When added to the company's securities and consumer loans it's holding for sale, its total net cash and securities come to $671 million.
That's half of the company's $1.3 billion market capitalization. Additionally, while LendingClub has been unprofitable for the past few years, management expects the company to become profitable in the second half of 2019.
So if avoiding de-listing isn't the reason, what is? In the press release, LendingClub CFO Tom Casey said, "As we drive toward our profitability goal, we have a number of simplification and efficiency efforts under way. We are pleased that the reverse stock split will have the dual benefits of both reducing our cost basis and also opening up the stock to new investors."
Of these two reasons, I think opening the stock to new investors is the main reason behind the move. Many institutions are prevented from buying stocks that are under $5, due to the perception they are risky, and that they line the pockets of brokers. While the effect of having a stock under $5 may be overstated, there are likely some slight negative aspects.
Additionally, LendingClub is looking to reduce costs for both itself and its investors. For investors, some (though not all) brokers charge commissions on a per-share basis, meaning trading more shares of LendingClub stock at a lower price could be more expensive than trading fewer shares at a higher price.
Companies also have to pay the New York Stock Exchange annual listing fees on a per-share basis, amounting to $0.0011 per share. At the end of the first quarter, Lending Club had about 434 million shares outstanding. After the reverse split, Lending Club will have around 87 million shares. The reduction should thus save Lending Club roughly $380,000 per year -- about the same amount as a salary for a C-suite executive.
Could LendingClub pull a "Priceline?"
While a reverse split is usually a sign of trouble, that's not always the case. Famously, Priceline, now called Booking Holdings (NASDAQ: BKNG), executed a 1-for-6 reverse split in 2003 after the tech bubble burst; it's now valued at over 87 times its post-split stock price.
LendingClub management will have a chance to explain the move, along with other cost-savings initiatives, on its earnings call on Aug. 6. In fairness, LendingClub has actually executed quite well over the past couple of years, but investors still aren't buying the stock. Maybe a reverse split and second-half profitability will be what it needs to get going.
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Billy Duberstein owns shares of LendingClub and has the following options: short August 2019 $13 puts on LendingClub. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Booking Holdings. The Motley Fool has a disclosure policy.