It's been a rocky road for shareholders of General Motors (NYSE:GM). Unfortunately, it's about to get even bumpier.
The distressed automaker announced plans for a 1-for-100 reverse stock split yesterday. Unlike a conventional forward stock split, where investors receive more shares as the stock's price is adjusted lower accordingly, a reverse split works the other way around. In GM's case, every round lot of 100 shares will become a single new share, at a price that will theoretically be 100 times higher.
It's a zero-sum game, though GM's filing has more to do with future dilution than simply a penny-stock share price. If GM is able to receive concessions from the United Auto Workers this month, swapping debt for equity will lead to the automaker's share count ballooning from 610 million today to a whopping 62 billion authorized shares.
If so, it's safe to say that GM's close at $1.85 yesterday is a pipe dream. With a fully diluted 62 billion shares, it’s unlikely that the market will value GM at more than $100 billion. The stock price is likely to be lower -- perhaps substantially lower -- so the reverse split makes sense from at least a cosmetic perspective.
GM becomes just the latest company to publicly consider a reverse stock split. Over the past year alone, several companies like Sirius XM Radio (NASDAQ:SIRI), Rite Aid (NYSE:RAD), and Six Flags (OTC BB: SIXF) have proposed reverse stock splits. These moves have typically been a matter of listing compliance as their stocks fell below $1 a share. Time Warner (NYSE:TWX) is mulling the possibility, after it completely spins off its cable operations.
Investors typically freak out over reverse stock splits. There are a few success stories -- like priceline.com (NASDAQ:PCLN) -- but most of the reversers (Sun Microsystems (NASDAQ:JAVA), for instance) are trading lower today.
On paper, it shouldn't make a difference. It's an even exchange. However, just as investors often bid up companies that declare forward stock splits based on optimistic assumptions, it's only natural to coat reverse stock splits with pessimistic assumptions.
Until we get a few more Pricelines in the winner's circle, that is unlikely to change.
