If there's something that is nearly taken as gospel in investing, it's the belief among investors that a reverse split is a sign of a company in big, big trouble.
In almost all cases this is true. Internet Capital Group (NASDAQ:ICGE), for example, had a reverse 1-for-20 split in May to bring its badly slumping stock back up over the $1 level that Nasdaq requires for companies to retain their listing. Someone who owned 500 shares of Internet Capital Group stock at $0.24 per share before the reverse split woke up the next day owning 25 shares at $4.85. The company viewed the ignominy of having a reverse split as being "less worse" than continuing to be at risk for delisting from Nasdaq. Though its shares had lost 99.5% of their value since the heyday in 1999, this was still a $200 million market capitalization company. Do the reverse split; live to see another day on Nasdaq. By the way, the all-time high for Internet Capital Group now that the reverse split has been factored in is $4,240 per share. Ouch!
There are a few cases when a reverse split doesn't come as a result of a big downturn in company prospects. These splits generally come as a result of other corporate actions: spinoffs, mergers, and going-private transactions. Just such a case happened today, and it's a situation I've been watching for a long time for an investment opportunity.
ALLETE (NYSE:ALE), a Duluth, Minn.-based holding company that controls Minnesota Power, a regulated electric utility, along with a Florida real estate business and telecom and coal-mining assets, spun off to shareholders its large auto distribution subsidiary, ADESA (NYSE:KAR), in June.
Now, you might wonder how a real estate operation, a utility, and a car distributor are related businesses. So, apparently, did the management at ALLETE. So it spun out ADESA, first by holding an initial public offering of 6 million shares and then by distributing ADESA shares to Allete shareholders yesterday. This would have had the impact of reducing ALLETE's equity per share and earnings per share, so rather than being dropped down to a $10 stock, ALLETE simultaneously had a 1-for-3 reverse split of its shares, so they trade at almost the same price per share as they did before the spinoff. There are two differences: Each shareholder now owns one-third of the shares he did yesterday, and he also owns shares in ADESA.
There are certain problems with being a stock that trades below $10. Some institutions have strictures in place restricting them from owning stocks that trade in the single digits, no matter how large the underlying company may be. As a company that is primarily an electric utility, the last thing that ALLETE wanted to do was make itself ineligible for investment by income-seeking institutions.
But watch ALLETE. Many times after a company has gone through some major corporate actions, performance numbers become skewed. Thus far this year it's had a major spinoff and now a reverse split. Expect some confusion as investors try to figure out whether they actually wanted to own a utility, a car distributor, neither, or both.
See also:
- A Reverse Split -- Ouch! by Tom Jacobs
- Priceline Goes in Reverse by Rick Aristotle Munarriz
Bill Mann owns no shares in any company mentioned in this article.
