Down But Not Out: Properly Implementing A Reverse Stock Split And Leveraging The Opportunity It Creates

Author:Mr Jay Frankl
Profession:FTI Consulting
 
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Reverse stock splits are widely viewed as a cosmetic fix by

public companies to raise the price of common shares. Reverse stock

splits are generally thought to be utilized for two principal

purposes: (1) to remain listed on an exchange; or (2) to entice

greater breadth of stock ownership, usually targeted at institution

al investors.

Furthermore, reverse stock splits are viewed by many as a

late-in-the-game effort by under-performing and/or out-of-favor

companies to reverse their fortunes without improving the

underlying business. Yet, empirical data shows that some companies

are able to implement a reverse stock split and, after that

inflection point, ultimately thrive. This intriguing point led us

to look more closely at why some companies succeed post-reverse

stock split while others fail.

From 1962 to August 2008, there have been over 2,000 occasions

in which a U.S.-listed entity implemented a reverse stock split

when its share price was less then $1 per share the day before the

split execution date.1 Academic literature suggests that

the resultant lack of marketability and/or liquidity for a stock

after a delisting can be significant, with a first day market

capitalization contraction of 18-20% and continued subsequent price

deterioration.2

FTI Consulting, Inc. ("FTI") has independently

reviewed the facts and circumstances surrounding many of the

entities that have implemented reverse stock splits since 1962, and

has also conducted an extensive review of published research on

reverse stock splits. The purpose of FTI's research was to

isolate success stories and examine the common denominators of

these successes. In sum, although the general trend for companies

that effect a reverse stock split is a reduced market

capitalization, there are numerous situations where market

capitalization of the reverse splitting-entity hold or even

increase. Please see the table below for several recent

examples.

Company

Date Of Reverse

Split

Market Cap At Time Of Reverse

Split (in Millions)

Market Cap 1-Year Later (in

Millions)

% Increase

CYCLACEL PHARMACEUTICALS INC.

03/27/06

$ 15.7

$ 158.0

905 %

FUTUREMEDIA PUBLIC LIMITED CO.

01/04/07

$ 0.1

$ 1.2

829 %

SEQUENOM INC.

06/02/06

$ 25.2

$ 192.2

662 %

DG FASTCHANNEL INC.

05/30/06

$ 42.7

$ 324.5

660 %

NEONODE INC.

04/02/07

$ 8.9

$ 59.5

568 %

PRG SCHULTZ INTERNATIONAL INC.

08/16/06

$ 21.5

$ 123.1

473 %

AMERICAN ELECTRIC TECHNOLS INC.

05/16/07

$ 8.9

$ 41.0

362 %

VIA PHARMACEUTICALS INC.

06/06/07

$ 10.2

$ 42.4

316 %

COMBIMATRIX CORP.

08/15/07

$ 21.6

$ 75.8

250 %

TAPESTRY PHARMACEUTICALS INC.

02/06/06

$ 8.3

$ 28.6

244 %

Gaining a better understanding of the factors associated with

the success stories is critical to assist management teams, boards

of directors and shareholders in making the determination of

whether or not to approve and move forward with a reverse stock

split.

In general, we found that the companies which succeed subsequent

to the implementation of a reverse stock split proactively

formulate a business plan to address any perceived or actual

operational underperformance, combine a properly sized reverse

stock split with effective communication to the investor community

about the merits of the company's underlying business plan, and

provide detailed, post-reverse stock split communications regarding

the progress in executing its business plan. Variations of this

formula can cast a reverse stock split as a critical inflection

point whereby management can attract the attention of investors,

build credibility and direct investors' attention to the

existing and growing value in the underlying business.

WHY IMPLEMENT A REVERSE STOCK SPLIT?

Two of the most common reasons that a company would implement a

reverse stock split are: (1) to maintain listing on an exchange;

and (2) to attract new pools of existing and future investors to

the market for its stock.

MAINTAIN A LISTING ON AN EXCHANGE

NASDAQ and the NYSE have somewhat different requirements for

initial and continued listing, yet both exchanges have listing

standards that require listed companies to maintain a minimum stock

price of $1 per share. Once...

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