Commentary: Stocks: The Case for Unsplitting

Two years after the Nasdaq bubble burst, some follies of the era seem more amazing--and more costly--than ever. Remember the craze for stock splits? There was even a Web site offering e-mail alerts of upcoming splits to speculators who bought the stocks, sure that they would soar.

And soar they did, at least initially. Ameritrade Holding Corp. (AMTD ), the online brokerage, split its stock three times within a year, multiplying the number of shares outstanding by 12. The stock jumped 7.4%, to $28.54, the day the third split was announced in June, 1999. It had already leapt 11% five months earlier, when founder and majority stock owner J. Joe Ricketts announced a 2-for-1 split. "The rise in our stock price reflects the financial strength of our company and the proven soundness of our business model," Ricketts bragged at the time.

These days, Ameritrade is in the dumps, trading around $6.75--down about 75% from the last split. And it has lots of company: A dozen stocks that still have a market cap of more than $1 billion were split during the bubble and now trade below $7 a share, including computer maker Gateway (GTW ), telecom outfit Lucent Technologies (LU ), and Internet equipment maker JDS Uniphase (JDSU ).

With little prospect that their stock prices will bounce back strongly anytime soon, such companies should consider helping out long-suffering shareholders--perhaps by way of reverse splits. Such an operation would entail consolidating, say, five existing shares into one new share. That would turn Ameritrade into a $33 stock. Donna Kush, a company spokeswoman, declined to discuss the matter except to note that at the last split, of 3 for 1, the stock was trading at more than $80 a share.

Of course, reverse splits might be read as a sign of bad things to come, but the strategy would have several advantages. Most important, it would make it much easier to trade the stocks, because it would put them back on the radar screens of institutional investors such as pension and mutual funds. These investors tend to shun stocks that fall below $10 a share. "It is a practical matter," explains Barry P. Barbash, former director of the Securities & Exchange Commission's division of investment management and now a partner at law firm Shearman & Sterling. "There may just not be enough liquidity for a mutual fund to get out so it can make its redemptions."

A higher unit price would bring other benefits. Brokerage commissions still include per share charges. A nickel-a-share commission on a $5 stock costs an investor 1% of the price, compared with one-tenth of one percent on a $50 stock. The difference between buying and selling prices quoted by dealers--the other key ingredient of transaction costs-- would tend to narrow as dealers quote wider spreads on low-priced shares, because they are usually more volatile than heavyweight stocks. Stocks priced under $10 proved 20% more volatile than the rest of the market over the past 10 years, says Steve Galbraith, stock strategist at Morgan Stanley Dean Witter & Co. Finally, low-priced shares are viewed as easier for would-be scamsters to manipulate.

The downside is that stocks undergoing reverse splits might be dumped by already frustrated shareholders. They might read the move as confirmation that they'll never recover their losses. After all, reverse splits were most recently known as part of the death throes of busted dot-coms. Webvan, the failed Internet grocer, did a 1-for-25 reverse split two weeks before entering bankruptcy. Also, some companies used them in vain attempts to keep listings on Nasdaq when their share prices fell below $1.

Despite their association with failing companies, reverse splits could work for companies with real value left after the tech bust. Higher-priced shares could end up making way for new investors with realistic expectations. The question is: How many executives have the nerve to do it?

By David Henry

    Before it's here, it's on the Bloomberg Terminal.