What is a reverse stock split?
A reverse stock split – also called a reverse share split, reverse split, or a stock merge – occurs when a company reduces its number of shares outstanding by effectively merging them. When this happens, each share increases in value proportionally.
A reverse stock split is the opposite of a stock split, when the number of outstanding shares increases and the value of each share declines accordingly.
Some companies may change their name after a reverse stock split, and have a different ticker symbol for their new shares. This is known as a name change and consolidation.
In a 1-for-2 reverse stock split, the number of outstanding shares declines by 50%, while the value of each share doubles.
Example of a reverse stock split
Imagine a company called John Doe Inc. had a total of 1,000,000 shares outstanding. In a 1:2 reverse stock split the number would be reduced to 500,000. If each share was worth $10, they would now be worth $20.
The company’s market capitalization – $10,000,000 – would remain the same. 10 x 1,000,000 equals the same as 20 x 500,000.
If you owned 500 John Doe shares beforehand, after the reverse split you would have just 225. However, they would each be worth double, so your total stake in the company would remain unchanged at $5,000. Your percentage ownership of the company would also stay the same.
If John Doe had an annual earnings per share (EPS) of $1.50, this number would now be $3 per share.
Why do companies opt for a reverse stock split?
Most stock exchanges, such as the New York Stock Exchange, London Stock Exchange or Nasdaq, have minimum price requirements. If the shares in your company have declined, one quick and easy way to make sure they do not go below the minimum is to execute a reverse stock split.
To remain listed in the New York Stock Exchange (NYSE), for example, a company’s share price must not dip below $1.
Imagine John Doe Inc. is listed in NYSE, and its share price plunges to $0.70. It will receive a delisting notice from NYSE.
John Doe executives may wait a while to see whether their shares recover over the $1 minimum. If this does not happen, they will probably vote for a reverse stock split. A 1:10 reverse split would place their shares at $7 – well above the minimum.
In most cases, investors see a reverse stock split as bad news, i.e. the company is in trouble.
The NYSE will suspend trading in a company’s stock after the thirtieth day if during that time it averages below $1 per share. Eastman Kodak’s shares were suspended in January 2012, as it slid towards bankruptcy.
Sometimes the NSYE waives its minimum price requirement. From March through June in 2009, the $1 minimum was suspended because so many companies were struggling following the global financial crisis.
The US Securities and Exchange Commission defines a reverse stock split as follows:
“A reverse stock split reduces the number of shares and increases the share price proportionately. For example, if you own 10,000 shares of a company and it declares a one for ten reverse split, you will own a total of 1,000 shares after the split. A reverse stock split has no effect on the value of what shareholders own.”