A reverse stock split is a corporate action in which a company replaces its existing shares with a smaller number of new shares, each worth proportionately more. In a 1-for-10 reverse split, for instance, every ten old shares become one new share. Each shareholder keeps the same percentage of the company, and the company's total value is not changed by the event itself. Companies use it mainly to lift a low share price.
It is the opposite of a stock split, which divides each share into several. Outside North America the same event is usually called a share consolidation. For holders it is a mandatory corporate action: no choice is offered, and positions are converted automatically.
How it works
The board proposes a ratio and, in most jurisdictions, shareholders must approve the change at a shareholder meeting because it alters the company's share capital. Shareholders sometimes approve a range of ratios and leave the board to choose one later. The company then announces the ratio and the effective date on which the shares begin trading on the new basis.
Taking a 1-for-10 reverse split as an example, a holder of 1,000 shares priced at 0.50 has a position worth 500. Afterwards the holder has 100 shares, and the price should open at about 5.00, leaving the value at 500. The number of shares in issue falls to a tenth, and per-share figures such as earnings per share rise tenfold, while market capitalization is unchanged. Where shares have a par value, it is normally multiplied by the ratio so that total share capital stays the same, although in some US states the company may instead keep the par value and reduce stated capital.
Why companies do it
The usual reasons are practical:
- Keeping a listing. Stock exchanges set minimum price standards. Both the New York Stock Exchange and Nasdaq can begin delisting steps when a share closes below one US dollar for a sustained period, and a reverse split is the quickest way back above the line. Failing that, the company may face the delisting process.
- Attracting investors. Some institutions will not hold very low-priced shares, and many brokers restrict margin lending on them.
- Reducing the share count. After heavy issuance, a company may have billions of shares outstanding at a tiny price, which makes price moves coarse relative to the tick size.
- Preparing for a transaction. A consolidation may precede a new share issue, a merger or a move to a different exchange.
A reverse split does nothing to improve the underlying business. Studies of past events have generally found that shares tend to perform poorly afterwards, largely because the companies that need one are often in difficulty. Exchanges have also tightened rules on repeated reverse splits used only to stay listed.
Fractions and small holders
Holdings that do not divide evenly by the ratio leave fractions. A holder of 1,005 shares in a 1-for-10 event is entitled to 100.5 new shares. Companies set out the fractional share treatment in the terms: fractions may be rounded up, rounded down, or sold in the market with the proceeds passed on as a cash-in-lieu payment. A holder with fewer old shares than the ratio may be cashed out entirely, and some companies have used large ratios deliberately to remove small shareholders.
Processing in the market
Because the new shares are legally a different security line, they are normally given a new ISIN and, in the United States, a new CUSIP, although the ticker symbol usually stays the same. On the effective date the central securities depository removes the old line from participants' accounts and credits the new line at the stated ratio. Custodians and brokers repeat the conversion in client accounts, pay cash for fractions and adjust cost records per share.
Open orders in the old line are generally cancelled, unsettled trades are transformed into the new security, and exchanges and clearing houses adjust listed options and other derivatives so that contract values are preserved. Index providers and data vendors apply an adjustment factor to historical prices so that charts do not show a false jump.