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This Pot Stock's Price Is About to Soar -- But For All the Wrong Reasons

By Dan Caplinger – Updated Apr 18, 2020 at 11:44AM

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Don't make the mistake of thinking anything's changed for this hard-hit cannabis company.

The cannabis industry has gone through a tough period, and things don't look like they're poised to improve soon. After a year's worth of disappointing numbers following the opening of the Canadian market to recreational marijuana sales, many cannabis companies are struggling from the financial effects of the coronavirus pandemic.

One stock in particular stands out as having gone from boom to bust in a notably harsh way. Aurora Cannabis (ACB -3.12%) has seen its share price fall more than 80% in just the past six months, underperforming even companies like Tilray (TLRY) and Canopy Growth (CGC -3.82%) in their recent struggles.

Marijuana investors are about to see Aurora's stock price soar. But don't get excited, because the upward move comes with a big catch for its shareholders.

Cannabis leaf prominently lit and centered in a pile of other leaves.

Image source: Getty Images.

The latest move from Aurora

Aurora Cannabis has been stuck in a tough situation for a while now. Expansion plans proved to be overly ambitious, saddling the company with debt and leaving it with significant losses. Efforts to raise new capital through stock offerings also added to the downward pressure on the share price. As a result of these decisions, Aurora's stock price started flirting with the $1 per share level back in March. Coronavirus-imposed challenges have kept the shares below that mark since then.

Stock prices below $1 per share are problematic because they endanger a company's ability to keep its stock listed on major exchanges like the New York Stock Exchange. To avoid getting delisted, Aurora decided to do a reverse stock split. That should have the desired effect of getting the stock price back above the $1 mark.

Yet the particular type of reverse stock split Aurora chose showed that it wanted to have a lot of breathing room. Aurora will split its shares 1-for-12, which means that it wants to multiply its stock price 12-fold after the split takes effect on or around May 11. With the price around $0.70 per share recently, the reverse split should send Aurora's stock price soaring to around $8.40 per share.

Here's the catch

At first glance, seeing shares jump a dozen times higher could make some shareholders jump for joy. But investors need to understand that just like regular stock splits, reverse stock splits don't do anything to the intrinsic value of the company or the total value of your shares.

In this case, the reverse split will mean that Aurora shareholders will own far fewer shares of a higher-priced stock. For instance, someone who owns 1,200 shares of Aurora before the reverse split at $0.70 per share has holdings worth $840. After the reverse split, that shareholder will have 12 times less stock -- just 100 shares. If the market price goes to $8.40 per share as expected, then the move won't have any effect on the $840 value of that investor's Aurora holdings.

Will a reverse split work for Aurora?

The track record for companies doing reverse stock splits isn't too great. More often than not, the move simply allows the company's shares to keep trading on the NYSE or other stock exchanges. Without improvement in business fundamentals, the stock price often keeps falling. Indeed, one reason why Aurora might have chosen 1-for-12 as its ratio is in anticipation of giving itself some breathing room if shares keep dropping after the reverse split takes place.

Outside the cannabis industry, there have been some success stories with reverse splits. Yet even then, the stock tends not to return to its former highs, instead trading in a range more consistent with the new conditions.

One example is American International Group (AIG -0.64%), which suffered dramatic dilution during the financial crisis. Following a 2009 reverse split, the insurance giant's stock stabilized and subsequently tripled from its financial crisis lows. However, it remains far below its split-adjusted highs of almost $2,000 per share in its heyday.

Aurora recently signaled another reason for the reverse split: its hope to raise more capital. In expanding its shelf offering registration, Aurora will be able to sell more stock to investors in secondary offerings if it wants to do so. The pot stock has a history of past dilutive offerings, and they've accelerated the descent in its share price over time.

Don't get tricked

So if you're surprised to see Aurora's stock price soar sometime next month, don't be. Investors will find out soon enough that they have a lot fewer shares in their portfolios -- and it'll still take a lot of work for Aurora to pull out of its tailspin and start realizing its full potential as a giant in the cannabis industry.

Dan Caplinger owns shares of American International Group. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Aurora Cannabis Inc. Stock Quote
Aurora Cannabis Inc.
$1.24 (-3.12%) $0.04
American International Group Stock Quote
American International Group
$51.38 (-0.64%) $0.33
Canopy Growth Corp. Stock Quote
Canopy Growth Corp.
$3.02 (-3.82%) $0.12
Tilray, Inc. Stock Quote
Tilray, Inc.

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