Sirius XM Radio (Nasdaq: SIRI) fought against it for years -- and won. Fellow Fool Rich Munarriz thinks YRC Worldwide (Nasdaq: YRCW) needs it bad. And now that Citigroup (NYSE: C) has finally succumbed to its allure, the question remains: Will the big bank's reverse split spell disaster for the company's stock?
As fellow Fool Cindy Johnson explains here, many think the answer is a definite yes. But judging from its first day of trading after its 1-for-10 reverse split took effect, Citi investors are answering with a resounding "I don't know." Having closed at $4.52 last Friday, the stock finished at $44.16 yesterday, amounting to a 2.3% loss on an up day for the market. But longer term, shareholders must wonder whether it would be better to get out now before any more damage gets done.
Why reverse splits are scary
It's been a while since the go-go days of the 1990s, when stock splits seemed to be a dime a dozen. But back then, companies paid close attention to their share prices, making sure that investors who were used to dealing in 100-share lots wouldn't find their stock too expensive as it grew in value. To remedy the situation, when a stock's price got too high, the company would split its shares. The split would have no effect on the value of current investors' positions -- they'd have more shares at a lower price each -- but it would make those 100-share lots cheaper for new investors.
Conversely, reverse splits were generally associated with companies that were on their way to permanent failure. As shares fell into penny-stock territory, reputable investors tended to avoid them, drying up demand and sometimes helping to accelerate the death spiral. Yet the move left investors with odd numbers of shares, perhaps turning them off to the concept and making them less likely to hold onto their stock.
Don't jump to conclusions
You shouldn't just dismiss every stock that does a reverse split as an ultimate failure. Rather, take a look at history for some good examples.
It's certainly true that plenty of reverse splits turn out to be mostly fruitless for shareholders. For example, Sun Microsystems did a reverse split in late 2007, only to see its shares drop as much as 85%. Oracle (Nasdaq: ORCL) came to the rescue with a buyout bid, but Sun shareholders still lost money after the reverse split.
Perhaps the biggest reverse split in recent memory came when AIG (NYSE: AIG) traded one new share for every 20 old shares investors held. The move came after the U.S. government hugely diluted existing shareholders with its bailout funding. Yet with the move coming nearly two years ago at $1.16, shares have rebounded sharply. Even with a recent swoon, they still are well above the $23.20 mark that represents the break-even level for the split.
Some reverse splits are even more successful. For example, priceline.com (Nasdaq: PCLN) infamously split its shares 1-for-6 in 2003, as the Internet bust decimated shares of just about every company with a dot-com at the end of its name. Yet the stock has since put in amazing gains.
Still other splits don't seem to make a lot of sense in the long run. LabCorp (NYSE: LH) did a 1-for-10 reverse split back in 2000, only to do 2-for-1 regular splits in each of the two ensuing years. All that splitting must have given the company a leg cramp.
Don't get tricked
Overall, though, the trend seems to be toward fewer splits and reverse splits. With the rise of discount brokers and cheap commissions, the need for 100-share round lots is almost a thing of the past. Big tech stocks now routinely trade in the triple digits without anyone calling for splits.
Still, for those companies that do split their shares, perception is everything. Yet whatever happens, history will likely end up making a connection between Citigroup's future and its reverse split where no connection really exists.
Keep track of Citigroup's future moves by adding it to your watchlist today.
