Reverse Splits Aren't All Bad

Dig deep into the pool of laggards and you will find companies giving reverse splits a bad name.

Unlike a traditional stock split -- where a company seeks to lower its share price by multiplying the number of shares outstanding -- a reverse split aims to prop up a stock's price by exchanging a set number of shares into a single new share.

Forward and reverse splits are zero-sum games. If a company has 100 shares at $100, it's worth exactly as much as having 1,000 shares at $10 through a 10-for-1 split or 10 shares at $1,000 through a 1-for-10 reverse split.

The math is fair, but good luck telling some investors that. Folks still often ask when companies with high share prices will declare forward splits. Penny stock speculators dread the moment when their companies resort to reverse stock splits.

Shifting into reverse
I got blasted two years ago when I suggested that Sirius XM Radio (NAS: SIRI) needed a reverse stock split. The stock was trading at $1, weaving its way in and out of exchange compliance.

Many Sirius XM investors hated the idea. There was no logical explanation for the displeasure. Would it have made a difference if Sirius XM had 6.5 billion shares at $1 or 650 million shares at $10? It would still be a $6.5 billion company. A higher price would have resulted in broader institutional ownership, but many felt that having broader speculator ownership was more appealing.

Thankfully for Sirius XM and its investors, no one's talking about a reverse split at Sirius XM anymore. The company has gone on to more than double. The satellite radio giant is consistently profitable, growing its subscriber base, and generating a ton of cash flow.

It will obviously take a long time for Sirius XM to get to double digits. Revenue would have to spike dramatically from its $3 billion annual pace to justify a $65 billion valuation. However, even skeptics have to admit that Sirius XM continues to take steps in the right direction with every passing quarter.

What if Sirius XM had executed a 1-for-10 reverse split when the company's board had approved the consideration two years ago? Would Sirius XM shares be worth more or less than $22.80 with 650 million fully diluted shares outstanding?

Before arguing that it would be worth less -- suggesting that Sirius XM would be less valuable than the $15 billion company it is today -- let's go over a few success stories.

In defense of reverse splits
(NAS: MOVE) went for a 1-for-4 reverse stock split four months ago. On Nov. 21, every four shares of Move at $1.54 were swapped out for a single share at $6.16. Easy. Zero-sum game!

A reverse split may be a sign of desperation, but is the parent company of and other real estate-related websites regretting the move? Probably not.

Move closed yesterday at $9.60, a healthy 56% pop since the reverse split four months ago.

It's not the only company that has gone for a reverse split and lived to tell the tale.

  • Shares of Coeur d'Alene Mines (NYS: CDE) have soared 74% since the silver miner executed a 1-for-10 reverse split at $1.40 three years ago.

  • Laboratory Corporation of America (NYS: LH) turned to a 1-for-10 split in 2000. Things have gone so well that it went on to declare a pair of forward splits after that.

  • The market applauds (NAS: PCLN) as the leader among travel website operators, but how quickly have we forgotten its 1-for-6 reverse split in 2003. The stock is a 27-bagger since its reverse as of today!

Splitting headache
Cynics will argue that I'm only highlighting the exceptions to the rule, and that's fair. They aren't the only companies to beat the market since declaring stock splits, but there are far more losers than winners after going for reverse split makeovers.

Then again, isn't that to be expected? A company declares a reverse because its share price is unacceptably low -- and that doesn't happen by accident. There are plenty of companies declaring desperate reverse splits on the way to zero. However, that was going to happen with or without the exchange adjustments. Wasn't it?

Reverse splits aren't all fatal.

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At the time thisarticle was published Motley Fool newsletter serviceshave recommended buying shares of Laboratory Corp. of America Holdings and Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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