Stock splits are an occasional tool used by companies to adjust their share price and outstanding share count without changing their overall market cap. The equity value remains unchanged, but management may consider artificially adjusting the share price to make it more appealing to retail investors.
The conversational artificial intelligence company SoundHound AI (SOUN +1.58%) has benefited from the rise of the technology in recent years but is also experiencing a challenging year that has sent its stock price sharply downward. Could a stock split be in its future?
What drives stock splits
I want to reiterate that a stock split does not change a company's overall market capitalization, and therefore it does not alter an investor's total equity position. So when shareholders see a company they own announce a split, they shouldn't be concerned that it will change their position's value.
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Let's take an example. Say an investor owns 2,000 shares of a stock trading at $500 per share for a total equity position of $1 million. Then that company announces a traditional 2-for-1 stock split, meaning investors receive two shares for each share they own. The investor would then own 4,000 shares at a share price to $250, so the equity position's total value remains unchanged.
Companies typically conduct traditional stock splits to lower their share price and make the stock seem more accessible to retail investors. Increasing the outstanding share count can also boost liquidity.
Reverse stock splits do the opposite, increasing a company's share price while reducing the number of shares outstanding. Investors will often see companies resort to this when the stock risks breaching compliance rules with a large stock exchange, such as the Nasdaq or the New York Stock Exchange. Both exchanges will send members a deficiency notice if their stocks trade below $1 per share for 30 consecutive trading days.
A reverse split can help companies regain compliance if they believe they can turn things around and want to remain on a highly liquid exchange, where they have the best exposure to a broad group of investors.
Will SoundHound AI soon conduct a stock split?
SoundHound has developed voice and conversational AI that helps companies enhance their operations and provide customers with better experiences. The company's solutions can be used to enhance customer service, automate food delivery, and integrate generative-AI voice capabilities into automobiles.
While SoundHound is down roughly 38% this year (as of Dec. 9), the stock is still up close to 92% over the past five years, as many investors are still bullish on the company's AI. However, it's easy to see why some investors might have concerns. The company trades at a market capitalization of over $5 billion but has an accumulated deficit of nearly $1 billion, representing the total losses incurred since its inception in 2005.
NASDAQ: SOUN
Key Data Points
The company has grown its revenue strongly this year but is still losing money, so it trades at a monster valuation. However, the market is aware of this and, as with many companies using AI, is betting that the technology will succeed and that the business can capture market share quickly, which will eventually lead to robust profitability. Nonetheless, it is still a bet with no guarantee of success.
That said, I see no imperative need for SoundHound to conduct a reverse stock split. The stock trades around $12.40 per share and is well in compliance with Nasdaq listing requirements. Furthermore, most of the company's outstanding shares are publicly held, so there is no pressing need to boost liquidity. A large portion of the public float is being borrowed to short the stock, but this doesn't necessarily mean that a split is warranted.
