Share consolidation/ Reverse stock split.

Recently one of my invested Real Estate Investment Trust (REIT) announced an intended unit consolidation exercise. This REIT is proposing that every five of it's existing units to be consolidated into one consolidated unit. For example, this means that an investor who has 5000 units of this REIT currently will see his number of units at the end of this exercise reduced to 1000 units. This is the basic idea of the term consolidation.

Common misconceptions regarding share/ unit consolidation

There are some common misconceptions to a share or unit consolidation (or otherwise known as a reverse stock split). Common misconceptions include the following:-

1. The investor will see a dilution of his holdings after the share/ unit consolidation.

2. The net asset value of the invested company will decrease after the share/ unit consolidation.

Share/ unit consolidation does not reduce the percentage interest of the investor in the invested company. There is no dilution to his holdings after the share/ unit consolidation. Let me illustrate with an example. Imagine there are four investors who intend to share 20 equal slices of a cake. Each investor is entitled to receive 5 slices of the cake (each investor gets 25% of the whole cake). Just before the cake is cut into 20 slices one of the investors suggests that it is too much of a hassle to cut the cake into 20 slices. Thus, all the investors together agree to do a cake slice consolidation of 5 slices to become 1 slice. Thus, each investor will only get 1 slice of the cake. This means the cake will now be cut into 4 equal slices instead of 20 equal slices. Each investor now gets 1 slice which is still 25% of the cake, just that the one slice has become a bigger slice by 5 times (since 5 smaller slices get consolidated into 1 big slice).

Also, in doing the cake cutting with consolidation of the cake slices, the total size of the cake has not dwindled or expanded. It is still the same old cake, just that it is divided into 4 equal bigger slices instead of 20 smaller slices to be distributed equally to each investor. Thus, the net asset value of a company remained unchanged after a share/ unit consolidation (compare this with the example of the total size of the cake which has not changed since no extra materials has been put into the cake to make it bigger nor any part of the cake taken away before dividing the cake for the four investors).

Reasons for share/ unit consolidation by a company/ investment trust

If a share/ unit consolidation has no material effect on the company and it's investors, then why does a company do share/ unit consolidation? Is it justifiable for such an exercise?

Any company can do a share consolidation or otherwise known as reverse stock split for various reasons. One of the reasons is to increase the share/ unit price of the company/ investment trust. Some stock exchanges do not permit stock price to be traded below a certain price, so a company that has too low a stock price has to do share/ unit consolidation in order to continue to be listed on the stock exchange. For example, a company share which is currently traded at $1/ share will see it's share price increase to approximately $5/ share after a 5-for-1 share consolidation. The total number of outstanding shares in the company will decrease by approximately 5 times since every 5 shares is consolidated into 1 share (eg. total outstanding shares of 5 million shares will be reduced to 1 million shares).

Another reason why companies do stock/ unit consolidation is to attract instituition investors. Institution investors mainly invest in companies with higher traded stock price (as such companies are "seen to be stable blue chips"). As such, there is more analyst coverage and institutional interest in such higher traded stock price companies (if one assumes higher traded share/ unit price equates to a blue-chip status). Thus, some companies can do share/ unit consolidation to increase their share/ unit price so as to gain institutional interest and analyst coverage. This is what I call, "to put on a premium branded suit on a man" so as to let the man look more attractive and gain higher prestige. However, the man is still the same man with same abilities and personality. Nothing much has changed except that he has donned a good looking suit.

Conclusion

In conclusion, when companies/ investment trusts do share/ unit consolidation, there is no material impact on their investors. There is no dilution of investor holdings in the company nor any change in the net asset value of the company after the share/ unit consolidation.

A share/ unit consolidation may be carried out by companies to gain institutional interest and analyst coverage. However, the investor must be careful to see that the fundamentals of the company has not changed for the better after the share/ unit consolidation (if one sees a share/ unit consolidation like a man who dons a good looking suit to make himself more attractive, but he is still the same person and has not necessarily become better in his personality and abilities). In such situations, I will still adopt a cautious attitude towards the company to continue to see that they do the right things to constantly improve their business as such share/ unit consolidation exercise may be just a "one-time putting on make-up" event.

"Excuse me sir, how will you like your cake to be cut?

20 equal small slices or 4 equal bigger slices?

We do not add extra materials or take away any part of the cake.

The cake is still the same total size no matter how you want it to be cut."