We sometimes see a big jump in the share price of one of the companies listed on the US Stock Exchange, and the reason is that the company decided to do the Reverse Split of the company's shares, so the share value increased several times.
What is Reverse Split?
It is an accounting trick, whereby the company reduces the number of issued shares, and thus the share price increases. If the number of company shares is 100 and the value of each share is $5, the company's valuation will be $500.
If the company decides to do a “Reverse Split” of its shares at a ratio of 1:10, this means that the number of shares will become 10 shares instead of 100 and the share price will increase to $50 instead of $5, but the value of the company will not change, it will become $500 as It was previously.
There's a difference between the ordinary stock split and the reverse split. The ordinary stock split is a process by which one share is divided into several shares, which contributes to reducing the value of the stock. Companies do this for several reasons, including increasing the purchase attractiveness of the company’s shares. More demand for it, as Tesla did when it split the company's shares 1:5, dropping the share price from $1,500 to $300.
In 2011, Citigroup bank decided to carry out an ordinary split of the company’s shares at a ratio of one share for every ten shares 1:10, as part of the recovery program. The share price decreased from $50 to $5 with the increase in the number of shares. At the annual shareholder meeting, Citigroup CEO Vikram Pandit said in response to angry shareholders that the situation has not changed before and after the split, he says, "This split is a bit like a piece of pizza, whether you have 10 slices or 12 slices, just a piece." The pizza hasn't changed in size."
While the goal from reverse split is to increase the share price and reduce the number of issued shares.
Why does a company do a reverse split?
Companies perform a reverse split of their shares in compliance with the terms of the stock exchange and to avoid removing the stock from the market. For example, the Nasdaq Stock Exchange (NASDAQ) and the New York Stock Exchange (NYSE) stipulate that the share price doesn't drop less than $1 in order not to be removed from the stock exchange with a correction period of up to 100 days, the companies perform a reverse split until its price becomes more than $1 in compliance with the terms of the stock exchange.
Last month, Naked Brand Group, a clothing and textile retailer, reverse split its shares by 1:15, increasing the share price from 0.67 to $6, with the company's valuation remaining the same.
In the year 2001, the period of what is known as the dot-com bubble, there was a significant decline in the share prices of companies. More than 700 companies undertook a reverse split of their shares in order to avoid their expulsion from the market.
What are the terms for reverse split?
It requires the company to take the approval of the Securities Commission first, and then votes for the shareholders on the reverse partition resolution in the agreed format.
In the event of disagreement and the company exceeding the compliance period specified by the stock exchange, the stock will be removed from the stock exchange and traded over the counter. OTC
What is the impact of this decision on the company's stock future?
The decision to reverse split the company's shares usually comes after the negative results of the company's performance, and a significant decrease in the share price occurs. The company performs the reverse split in order to avoid removing the share, and this gives a bad reputation to the company, which makes investors sell their shares.
Sources
https://www.reuters.com/article/idINIndia-56504120110421
investing.com/equities/naked-brand-group-inc-company-profile
https://www.marketwatch.com/story/teslas-stock-run-leads-to-5-1-share-split-2020-08-11?mod=article_inline
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