Can Reverse Splits Undo the Damage?


By Amy Tsao Times sure have changed. In the bull market's heyday, stock splits, in which one share becomes two or more, were a common strategy that companies -- often techs and dot-coms -- used to make their stock more affordable. Now such companies rarely announce stock splits. Instead, with the market in a deep funk and tech shares tanking, the formerly rare tactic of "reverse stock splits" is becoming more common, analysts say.

Reverse stock splits used to be favored mainly by the smallest public companies, which used them to generate interest from big investors. But market watchers increasingly expect that larger companies on the brink of being sent to the so-called Pink Sheets -- where stocks end up when they no longer meet the major exchanges' listing requirements, particularly price -- will consider braving what was once a stigma.

After a 10-for-1 reverse split, a company with 100 million shares at $1 apiece could instantly become a $10 stock with 10 million shares trading. For now, not much research is available on the frequency or success of reverse splits. Soon it will be, however, says Len Rosenthal, professor of finance at Bentley College. "Due to the meltdown, there'll be a lot more examples to look at over the next few years," he predicts.

PLENTY OF CANDIDATES. Reverse splits could even be embraced by brand-name companies. Consider that Sun Microsystems (SUNW), JDS Uniphase (JDSU), Ciena (CIEN), Ericsson (ERICY), Nortel (NT), and Lucent (LU) are all trading in the low single-digit range -- in a market that's wobbly at best.

None has announced plans for a reverse split. But because a huge number of their shares are outstanding, momentum investors can trade heavily in them and fuel unwanted volatility. At the same time, reverse stock splits can help to attract institutional investors, which are often prohibited from owning stocks that trade lower than $5 a share.

Mike Balkin, fund manager of William Blair Small Cap Growth Fund (WBSIX), argues that a powerful case could be made for some marquee outfits to adopt this tactic. Stock splits "allow these companies to stay public and get their house in order."

Several tech companies are already testing the waters. Shares of MicroStrategy (MSTR) traded as high as $313 in March, 2000. With its stock closing at 50 cents on June 28, the business-intelligence software maker is a mulling a reverse split. On July 23, shareholders will vote on a plan that would combine up to 10 cheap shares into a single more expensive one.

ANTIDOTE TO DELISTING. Verticalnet (VERT), a Web-based supply-chain software company, and Caldera International (CALD), which makes Linux-based software, have announced similar plans in recent months. Caldera's shares were the subject of 4-to-1 reverse split in March, 2002, and have since traded lower. Even blue-chip AT&T (T) says it will hold a 5-for-1 reverse stock split after the plan to spin off its cable business to Comcast (CCZ) is completed.

MicroStrategy, based in McLean, Va., says the reverse split will help it attract institutional investors. The move is also meant to keep the stock, which has been trading under $1 for some time, from being delisted from Nasdaq. MicroStrategy says it's not a signal of weakness. "The company has righted the ship, and from a fundamental standpoint, we're in a stronger position now than ever," insists Treasurer Bill Chatterton.

Indeed, some analysts say MicroStrategy, which was sued by shareholders who lost billions when it fudged its financial results in the late '90s, has trimmed costs considerably. They also see good prospects for a new product line and say MicroStrategy is positioned to benefit when demand for its software improves.

READING THE SIGNS. Investors should bear in mind, though, that companies rarely resort to a reverse split out of strength. In MicroStrategy's case, its financial health may be improving in some ways, but it still faces serious balance-sheet concerns. It ended the last quarter with $33 million in cash, but it has a $10.2 million interest payment due at yearend. "It doesn't have a lot of cushion from a cash standpoint. If things get worse, it could be backed into a corner," says David Hilal, an analyst with Friedman Billings Ramsey, who recently downgraded the stock to market perform from accumulate.

While a reverse split may help some companies avoid short-term pain, such moves can accomplish only so much. Figuring out which will survive the rough economy and which have problems that are irreparable will likely become an even greater challenge as reverse splits become an increasingly common survival strategy. The trick for investors is to focus on the company's health, not the stock's. Says fund manager Balkin: "If you believe the company is a long-term survivor, that's what you should be paying attention to."

In the end, "a split doesn't change anything about a company," says Bentley College's Rosenthal, who adds: "The question is: Is it signaling something?" Investors may have a lot more of those signals to interpret over the months to come. Tsao covers financial markets for BusinessWeek Online in New York


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