Reversals of Fortune: Sewing Up Splits.

The reverse stock split is perhaps the true mirror image of a general stock split--not only in deed and process, but in emotional impact levied by the investment market.

In a stock split, a company increases the amount of shares outstanding, thus bringing down the price of a stock, which makes the price more accessible. The market, perceiving the split as evidence of the company's good health, receives the move enthusiastically.

Conversely, the reverse stock split reduces the number of shares outstanding, thereby raising the stock price--no doubt a relief to investors who already own shares. But the perception on the Street is that the company is dealing from a place of weakness.

A sizeable body of research indicates reverse split stocks don't perform well post-split, but there are some exceptions. When a small cap stock reverse splits, it immediately offers a price range more acceptable to traders. Or at least that's the hope of two small companies, one of which has completed a reverse and the other presently attempting the move.

Three years ago, Dallas-based AMRESCO was a growing diversified financial services company with about $650 million in revenue. The problem was that it funded its business through the securitization market, which was pounded mercilessly by the 1998 credit crunch--and AMRESCO never recovered. Today, it's a small, middle-market lender, one of 14 bank licensees able to originate Small Business Administration loans. Its stock price, once in the $30 range, dove to under $1. In late summer it completed a one-for-five reverse and today it's trading at about $2 a share.

The driving factor for the split was actually the specter of being delisted, says CEO Randolph Brown. "So as a way to maintain liquidity for stockholders we did a reverse." Secondly, AMRESCO's market cap shrank as a result of its financial troubles, which meant the number of shares outstanding was proportionately large relative to current market capitalization, making it very difficult to show improvements on a net earnings per share basis. "When AMRESCO generates earnings some period down the road," says Brown, "it will be more meaningful on a per-share basis as opposed to having such a large outstanding share base that does not rightly reflect the company."

Matria Healthcare of Marietta, GA, faced a similar dilemma. The $250 million provider of comprehensive disease management programs, services, and supplies to health plans, saw its stock drop to $2.50. For a time, Matria considered reducing the number of its shares outstanding, which total 38 million. Now, with a weak stock price and other related factors persisting, the company finally decided to go that route, announcing in September its plan for a one-for-five reverse. "With the number of shares outstanding, our earnings per share are small, less than 10 cents per share," reports CEO Parker Petit.

There were other considerations, too, says Petit. "Matria needed to get its stock price above $10 a share because many institutional investors don't invest in stocks under that range. Matria has a strong position in fee management programs, which will be one of the cornerstones of healthcare in the years ahead, and it needed to keep its stock price on broader radar screens." Petit maintains Matria is a strong company and the reverse is not due to weak performance. "We have not been growing very rapidly, but the company has very strong cash flows and 15 percent operating profit." Still a reverse split is a gamble. Even Petit says, "when companies do a reverse, capitalization drops" as shares are sold down after the split.

This was a key issue facing another company, Phoenix-based WAVO. The $13 million Internet digital media company had seen its stock free-fall from $20 a share in '94 to under $1. In autumn, WAVO announced it was considering a reverse stock split, but after talking with NASDAQ, decided against it.

"NASDAQ officials suggested we not proceed with the reverse and focus on business fundamentals--as we have customers; are a viable, long-term business; and are now turning toward profitability for the first time ever," explains CEO Michael Coffin. The other factor in its decision, one many in the current market could identify with: The company has been a victim of vicious short-selling. "If we did the reverse," says Coffin, "we would only be feeding the short sellers."

Steve Bergsman is a business writer based in Phoenix, AZ.