Lucent Proposes Reverse Stock Split
The board of directors will set the ratio, which is expected to result in a common share price in the range of $15 to $25, according to the company.
Lucent’s rival, Nortel Networks Corp. (NYSE/Toronto: NT), announced a similar plan last month (see Nortel Outlook Worsens). The company said it would be taking the issue to its shareholders at its annual meeting in April with a price target between $10 and $20 per share.
As of October 17, 2002, the average closing share price of Lucent’s common stock had fallen below $1.00 for the past 30 days (see Lucent Dabbles Under $1). Nortel has also consistently closed below $1.00. If the average share price of a company trades below this benchmark for 30 consecutive days, the NYSE may delist it from the exchange.
This would be devastating for either company. Its stock would likely be relegated to trading on the “pink sheet” exchanges, which could preclude large institutional investors from investing in it. (Many large funds have rules about owning stocks trading on these exchanges). What’s more, many also have rules about holding stocks that are trading below $5 per share, so getting the share price above $1 is also critical.
“I don’t think that they had a lot of choices,” says Simon Leopold, an analyst with Merrill Lynch & Co. Inc.. “It’s not a question of whether this is a smart move versus a stupid one. It’s accepting reality.”
A reverse stock split is designed to do two things: reduce the number of outstanding shares and inflate the price of the remaining shares. Let’s say a shareholder has 100 shares priced at $1 each. The company decides to do a 10 for 1 reverse split. In the end, the shareholder will end up with 10 shares in the company instead of 100, but the value he holds in the company, which is $100, remains exactly the same.
“Stock splits don’t mean anything really,” adds Leopold. “It doesn’t change any of the facts of the company. It’s more of a psychological play.”
The reverse split gives the illusion that the stock is trading for a higher value, and the hope is that it will restore investors’ faith in the stock. But often, this trick backfires. In the past, companies playing the reverse split card have seen their share price gains quickly disappear with share prices returning to previous levels or even below their pre-split values.
“Generally, reverse stock splits are not a good sign on Wall Sreet,” says Steven D. Levy, an analyst with Lehman Brothers. “However, if you’re going to do it, you should follow what Nortel and Lucent are doing. They are both getting very aggressive with their price targets.”
Unlike other companies in the dotcom era which used smaller ratios to get their stock just above a dollar, Lucent and Nortel will likely use much larger ratios, exchanging anywhere between 10 and 25 shares for one. And while this is by no means good news for Lucent, analysts are not throwing in the towel just yet on the company.
“The telecom industry is not going away,” says Leopold. “It will always need suppliers. And the ones that survive will be worth more than they are today when the sector recovers.”
As for Lucent specifically, he says the company is a survivor. “We don’t see solvency as an issue and expect that when the industry recovers Lucent will be there.”
Lucent's stock is trading down $0.05 (6.67%) today, to $0.70 a share. Nortel is trading at $0.59.
— Marguerite Reardon, Senior Editor, Light Reading