What Is Share Consolidation?
In this article, we will take a look at share consolidation, also known as a reverse stock split. We will provide a definition for the term, examine how it affects investors, highlight a recent reverse stock split example and much more!
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What Is Share Consolidation?
Share consolidation is the opposite of a stock split, something which perhaps becomes more obvious when you consider its other name, reverse stock split. But what does this mean exactly?
During a reverse stock split, a company essentially merges, or consolidates, its existing shares by a predetermined ratio. This can be any ratio the company chooses, and is typically expressed as 1-for-2, 1-for-5, 1-for-10 and so on. A reverse split of 1-for-5 would mean that the total number of shares outstanding will be reduced by a factor of 5.
This reduction in the number of shares is accompanied by a proportional increase in per share value, meaning that the company’s market capitalisation and, consequently, an investor’s stake, is not affected by the share consolidation – in and of itself.
For example, let’s say a company has 1,000,000 shares outstanding priced at $5 per share and decides to reverse split its stock by a ratio of 1-for-2. Immediately following the consolidation, the company would have 500,000 shares (1,000,000 / 2) outstanding priced at $10 per share ($5 x 2).
You will note that, as both numbers have changed by the same proportion, there is no impact to the company’s overall value. Its market cap both pre and post-split is $5 million.
Is a Reverse Stock Split Good?
So, is share consolidation good or bad? As demonstrated above, a reverse stock split in and of itself does not affect a company’s market cap and, consequently, it does not have any material impact on an individual investor’s stake in the company.
However, it’s typically not a good look for a company. To understand why, ask yourself, why would a company feel the need to conduct a reverse stock split in the first place?
Whilst a stock split is often undertaken as the result of a company’s share price becoming too high, a reverse stock split is conducted for the opposite reason, when share price has dropped too low.
Consequently, whereas a stock split is often perceived as a bullish sign, share consolidation can be interpreted as a sign that a company has been underperforming and/or struggling financially. Subsequently, many investors view reverse stock splits as a red flag and their announcements are often followed by a decrease in share price.
Why Do a Reverse Stock Split?
There are a number of reasons why an embattled company may choose to reverse split its shares. It essentially boils down to the company wanting to boost share price.
1. Avoid Delisting
Exchanges tend to have requirements that specify that a stock’s share price must remain above a certain threshold or it risks being delisted from the exchange.
For example, the New York Stock Exchange (NYSE) requires that a listed security’s price must maintain a minimum average closing price of $1 per share over a 30 consecutive trading day period.
2. Boost Investor Appeal
There is generally a negative perception amongst investors of stocks which trade in the low single digits, so-called penny stocks. They are viewed as risky investments, with small fluctuations in price resulting in relatively large percentage changes in stockholdings.
Furthermore, many institutional investors actually have policies prohibiting them from investing in stocks which are priced below a minimum level. A stock consolidation boosts price and, subsequently, may attract more attention from market participants, both retail and institutional.
Virgin Galactic Reverse Stock Split Example
On 18 April 2024, spaceflight company Virgin Galactic released a notice for its annual meeting, which included a proposal to ask shareholders for approval to enact a reverse stock split. Chief amongst its reasons for doing so was to maintain its listing on the NYSE.
The day this statement was released, Virgin Galactic’s share price had ended the session at $0.97 following a painful period of decline for its investors. In less than two years, share price was down by 98%.
On 12 June, Virgin Galactic’s share price closed at $0.82 and, after the session close, the spaceflight company announced that it would be pressing ahead with a reverse stock split of 1-for-20. The following day, share price opened 13% lower.
The reverse split took effect on 17 June 2024, with Virgin Galactic’s newly consolidated stock opening the session 27% lower at $10 per share, the equivalent of $0.50 in pre-split terms (versus a closing price of $0.69 the previous day). It ended the day at $11.70 ($0.59 pre-split).
From the date the company proposed its share consolidation to the close of the market on its first day post-split, the company’s share price dropped 40%.
Whilst this implies a negative market reaction to the Virgin Galactic reverse stock split, it’s worth bearing in mind that it happened during an extended period of decline, which started long before the initial announcement. In the chart below, the three red lines highlight the three dates mentioned above.
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FAQ
What happens to share price when shares are consolidated?
When a reverse stock split takes place, a stock’s share price is increased by the same ratio by which shares have been consolidated. Consequently, share consolidation in and of itself should have no impact on a company’s market capitalisation.
Do stocks usually go up after a reverse split?
Whilst a reverse stock split in itself has no effect on the value of a company, it is typically perceived negatively by the market. Consequently, the announcement of a reverse split is often followed by a fall in share price.
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