For years, reverse stock splits have been seen as window dressing, or a desperate attempt by tiny companies to avoid being delisted. But what about the reverse splits now being completed or considered by such companies as AT&T Corp., Lucent Technologies Inc., and Palm Inc.?
Despite analysts' disdain for them, there are some practical reasons for doing reverse splits. One reason is to appease institutional investors. "A lot of investment funds have covenants that don't let them buy stocks under certain prices--usually $3 or $5," says Vincent Sbarra, a senior partner with HBC Capital. Adds Ulrico Font, senior analyst for Ned Davis Research, everybody feels most comfortable with stocks priced between $5 and $50.
The loss of institutional investors was one reason Palm conducted its 1-for-20 reverse split in October, admits CFO Judy Bruner. But both Bruner and Chuck Noski, former CFO of AT&T, say the primary reason for their reverse splits is restructuring efforts that involve spin-offs. Palm, for example, plans to separate into two companies--one for its handheld devices, the other for its operating system. Yet with its presplit stock trading barely above Nasdaq's $1 minimum, the resulting shares of both companies wouldn't otherwise meet listing requirements.
Noski says that if AT&T sold off its cable TV unit, its remaining shares would trade at $4 to $5. Without the planned one-for-five reverse split, that would put AT&T in the red zone for institutional investors. The post-sale price would be way below the median share price of others in the S&P 500. Which brings up another practical reason for reverse splits: fear of embarrassment.