Today’s little banking scam involves Citibank, the 3rd largest bank in the world, performing a maneuver called a “reverse stock split.”
Background- In the normal world of business, publicly traded companies split their stock so that there are more shares on the market and each share costs less than before the split. This offers more liquidity (more shares available for buying and selling) as well as lowering the price per share so that more investors are able to purchase shares.
Without stock splits the value of a company’s assets increase (that is what they are supposed to do) and the cost per share increases. The best example is Berkshire Hathaway (BH), Warren Buffet’s company. BH owns several companies in their entirety (Dairy Queen, Helzberg Diamonds, See’s Candies, Redwing Shoes, Geico Insurance) as well as major stakes in publicly traded firms including Coca Cola, Gillette and Wells Fargo to name 3. The value of these companies has increased over time. So has the value of BH. Founded in 1963, BH has never had a stock split. In fact, shares of BH were trading at $75,000 per share in the last year or two. More recently, the share price has been at $35,000. Still too rich for most investors.
Citibank, whose shares historically trade at $50 but has recently traded at $1 per share, is proposing a reverse stock split in ratios of 1-2 up to 1-30. At the 1-30 ratio the share price would skyrocket to $30 per share. This price seems more proper for a major banking institution. However, this would reduce the number of shares accordingly and the company would not have any greater value than prior to the split.
Example- You start a lawn mowing business- “Prestige and Honor Lawn Service”. Your relatives and neighbors invest a total of $1000 in your business for which they receive shares in the company at 1 per each dollar invested, There is a total of 1000 shares. The company is worth $1000.
Over the years your business prospers as you gain new accounts and take good care of your customers. Your lawn mowing company is making 10 times as much money as when you began and each share is now worth $10. You decide to do a 5-1 stock split which makes the price per share $2. Everyone is happy because they now own 5 times as many shares and each share is worth twice as much as when they first invested their money. There is now a total of 5000 shares at $2 per share. The company is worth $10,000.
You float along on your reputation and become content, lazy and sloppy and start spending your time thumbing through riding lawn mower catalogs instead of taking care of your customers. The customers fire you and you are left with only a couple of accounts. The value of your company is now worth only 10 cents per share. There is still a total of 5000 shares. The value of your company is now $500. Your investors are furious and no longer trust you.
You decide to hire ”Dewey, Cheatum and Howe, Inc.” to perform a reverse stock split of your company at the ratio of 1-10. That means everyone must turn in their old shares and receive “new” shares. They receive 1 new share for every 10 old shares they turn in. After the split there are 500 shares each worth $1. The value of the company is still $500 but your investors and the rest of the uneducated world “feel better” because the shares of ”Prestige and Honor Lawn Service” is once again trading at $1 per share. They entirely miss the reality that they now hold 1 10th the number of shares as before and that the value of their investment has decreased 90%.
You look up from your riding lawn mower catalog just long enough to muse “what a wonderful world!”
That’s all for today.