CNOOC and the Invisible Split

One of my news feeds began chirping that Chinese oil and gas giant CNOOC (NYSE: CEO) had announced a 5-for-1 stock split yesterday. At a current share price of $42 per share, that would reduce each to a little over $8 apiece.

Some companies argue that they want increased liquidity in their shares, so they slice and dice them after a substantial run-up. There's exactly no fiscal benefit to doing so, but heck, stock splits just seemingly ooze success. And people get excited about them, irrational as that may be.

(To see such irrationality in action, check out what happened a few weeks back when Taser International (Nasdaq: TASR) surged almost 14% based on news of a 3-for-1 stock split. Irrational. Fun, perhaps, but irrational.)

But the above misses something important. CNOOC is not about to trade at $8 per share, unless the market for the company's shares actually collapses. We're not talking about the instruments that trade on the New York Stock Exchange. Those aren't actually shares. They're a derivative instrument called American Depositary Receipts, or ADRs. They act almost exactly the same as shares, but there are differences.

In the case of CNOOC, each ADR traded in New York is currently comprised of 20 shares trading in Hong Kong. At the moment, each CNOOC share trading in Hong Kong costs HK$16.45. At present rates of exchange, that equals about US$2.11 per share of CNOOC. But since the ADR is 20 shares, the equivalent for each stub traded in New York is US$42.34.

Under the conversion plan, the ADRs will no longer be worth 20 shares, but 100. so even though there is a "stock split," the CNOOC shares owned by the overwhelming majority of investors in the U.S. will remain exactly the same price. The underlying shares, though, will drop from HK$16.50 (US$2.11) apiece down to five shares at HK$3.30 (US$0.42) each. That's right, CNOOC is turning itself into a penny stock. But why?

Just as the majority of companies in the U.S. seem to prefer shares priced between $10 and $100 apiece, there are conceptions of "normal" share prices in other countries. In Hong Kong, just as in Britain, 1,000 shares is considered a round lot, whereas the number is 100 in the U.S. As such, companies with low per-share prices do not necessarily have the same stigma in Hong Kong as they do in the U.S.

By dropping the company's Hong Kong per-share price down by a factor of five, CNOOC is merely bringing its share price in range with its compatriot oil and gas company, PetroChina (NYSE: PTR). PetroChina trades in the U.S. at about $48 per ADR, but each ADR is comprised of -- you guessed it -- 100 shares.

So the CNOOC stubs trading in the U.S. will not change at all. Again, since we're talking share splits, the difference is only cosmetic -- there's no economic gain or loss to be had. But it's an opportunity to observe that, although foreign companies may trade freely in the U.S., they are not the same as U.S. companies, nor are they beholden to the same rules. In some cases -- most notably Indian computer firm Infosys (Nasdaq: INFY) -- the price of an ADR can trade at a value completely unhinged from what the equivalent number of underlying shares could be purchased in the home country if such a purchase were possible.

So, no, it's not likely there will be any $8 CNOOC shares floating around anytime soon. If there were, it would be from an event far less benign than a stock split.

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