SoFi Technologies (SOFI 2.83%) has gotten some attention in the marketplace in recent months. It is one of the few companies to wholeheartedly embrace fintech while operating a traditional bank. Buying the naming rights for SoFi Stadium, where the NFL hosted the 2022 Super Bowl, also added to its name recognition.
However, with a share price of only around $6, it's now considering a proposal to allow its board to execute a reverse stock split. While a reverse split may make sense from a particular perspective, SoFi would probably better serve its shareholders by rejecting this proposal.
SoFi will hold its annual shareholder meeting on July 12. On its proxy statement is a proposal allowing (but not requiring) the company to institute a reverse stock split between the ratios of 1-for-2 and 1-for-10 shares.
On the surface, this proposal appears understandable. In a technical sense, it changes nothing for shareholders. With a 1-for-10 reverse split, 1,000 shares at $6 per share become 100 shares valued at $60 per share, amounting to no change in shareholder value.
Moreover, most stocks priced at around $6 per share are small-cap stocks, or companies with market caps between about $300 million and $2 billion. With a market cap approaching $5 billion, SoFi is well into mid-cap status, a status that a higher stock price could better reflect.
The problem with reverse stock splits
However, much like stock splits can have a positive psychological effect on a stock, reverse stock splits can bring negativity. The main reason is that reverse stock splits can imply (and usually indicate) genuine troubles. Hence most companies only resort to such moves out of necessity.
For example, the major indexes will delist companies that consistently trade below $1 per share. Under such circumstances, companies may reluctantly approve a 1-for-5 or 1-for-10 reverse stock split to prevent such an occurrence.
Still, numerous companies that have tried this strategy only delayed the inevitable delisting. In many cases, the shares again dropped below $1 after a reverse split.
SoFi will likely not face such an eventuality, and some analysts believe it can outperform the rest of the lending industry. It claimed a membership base of almost 3.9 million at the end of the first quarter, 70% higher than year-ago levels. SoFi also reported 69% year-over-year revenue growth in Q1. Such results point to a level of strength that would probably make a reverse stock split unnecessary.
Additionally, at just under $6 per share, SoFi trades just above its book value. If its share price fell to $1 per share, the price-to-book value ratio would have to fall below 0.2, an unlikely occurrence unless the business collapses.
Lessons from the Booking Holdings reverse stock split
SoFi's board should also consider the reverse stock split of Booking Holdings (BKNG -0.67%), then known as Priceline.com. After struggling to break the $5-per-share range, Booking Holdings instituted a 1-for-6 reverse stock split in 2003.
However, over time Booking turned its business around, so much so that its price briefly surged above $2,700 per share last February. Even though it has now fallen below $1,800 per share, the stock sells at a level where whole shares are unaffordable to some small investors.
Had the reverse split not occurred, its record price would have moved no higher than the $450-per-share level, and would sell for under $300 per share today. In other words, the reverse split was wholly unnecessary and made it inconvenient for some investors to buy the shares.
SoFi's shareholders should reject the reverse split proposal. While it would appear to change nothing, such actions come with negative perceptions and rarely occur voluntarily.
Moreover, Booking Holdings has shown that reverse stock splits can lead to an unnecessarily high stock price even when they succeed. Instead of increasing the stock price by combining shares of the consumer finance stock, SoFi should focus on expanding the customer base, increasing revenue, and bringing the company to profitability.