Biotech StemCells Inc. tried an accounting trick 3 weeks ago to make its stock look better and regain compliance for Nasdaq listing requirements.
The trick didn’t work and today the stock lost 81% of its value on volume nearly 20 times normal. The stock closed at $0.57 down $2.46 on the Nasdaq exchange.
Related: SPORTS AUTHORITY GONE--WHO'S NEXT?
Oh, By The Way …
Today’s market reaction wasn’t just about accounting sleight of hand. It was also about a press release in which the company announced it would terminate a disappointing study.
Then roughly 1,000 words later, this statement appeared: “The Company also announced that, in light of the decision to terminate the Pathway Study, the Company's available strategic alternatives and its current cash position, the Board of Directors approved a plan to wind down the Company.”
The point of a reverse stock split, also known as a stock merge, is to increase the value of a single share by combining several shares into one. A 1-for-5 split, for example, in which 5 shares worth $1 each combine to form a single share worth $5, could be undertaken to make the stock more attractive to funds – many of which won’t buy stocks that sell for less than $5.
The move could also be undertaken to put the company in compliance with the exchange on which it is traded – which was the main reason BioTech did its reverse split.
Some Good Some Bad
Although studies indicate the majority of reverse stock splits simply do not work over the long term, some do pan out. One of the most often cited examples is Citigroup (NYSE:CC), which did a 1-for-10 stock split in 2011. The result - a stock that traded for less than $5 suddenly became one worth $40 (although investors made nothing on the deal). Today Citigroup trades north of $46.
Biotech is not the only example of a reverse stock split that simply failed to change the outcome. Others that fizzled include Sun Microsystems, which did a 1-for-4 split in 2007, then promptly fell 85% before being taken over by Oracle Corp. (NASDAQ:ORCLB).
Recent And Upcoming Reversals
Since the net result of a reverse stock split is that the amount of the investment remains the same, does it matter whether you buy shares before or after the split? If you are buying for the long term, it likely does not matter.
If the company’s strategy – to remain or regain listing compliance or to attract institutional investors – works and stock prices rise, you could come out ahead either way.
Some experts, however, advise against buying a stock undertaking or about to undertake a reverse split based on the simple premise the company’s share price is low and the company’s financials may not justify an investment in that firm.