It's an optics game now. Beaten up by weak demand for its much-delayed plane and savaged by slumping investor confidence, Bombardier Inc.'s chief executive officer needs to flip the script and present a new image to world.
The share consolidation announced Wednesday, also known as a reverse stock split, is designed to do just that. Immediately after it's complete, Bombardier's share price will pop, and that should prevent anyone from being able to say the plane maker's shares have fallen below $1 again. Bombardier can't endure that kind of press for much longer.
They sound sophisticated, but reverse stock splits are rather simple. Assuming Bombardier opts for a 10:1 ratio – management hasn't finalized the exact figure yet – existing investors who own 10 shares will suddenly own only one. To compensate, the share price will jump by 10 times, say from $1 to $10, so the total value of shares owned won't budge.
While being able to talk about a $10 stock is much better, psychologically speaking, for Bombardier, the reverse stock split sends a pretty ugly signal to the market. Booming companies don't consolidate shares, because their stocks are already soaring and the last thing they need is to push them higher. In late 2013 Toronto-Dominion Bank's stock price was nearing $100, and the lender decided to split its stock two-for-one, because $100 is a big psychological threshold it didn't want to cross.
Reverse stock splits, instead, are commonly used by struggling companies. They gained notoriety during the global financial crisis when major financial institutions such as a Citibank and American International Group Inc. used them. At that time, about 10 per cent of the S&P 500 was trading under $5 per share, according to Bloomberg, and the expectation was that more companies would have to use them to boost investor confidence. Luckily the market started to recover in in March, 2009, and the changing tide lifted most boats.
Whether reverse stock splits actually work is up for debate. As happened after the financial crisis, sometimes the broad market recovers, so it's hard to tell whether it was the consolidation that did the trick, or simply a traditional market rebound.
Studies of the tactic are also mixed. An analysis by Birinyi Associates of the S&P 500 from 2000 to 2010 found that nine of the 12 companies that executed reverse stock splits had their share prices climb higher (after taking into account the gain in the reverse split) in the first year by an average of 75 per cent.
But a 2008 study found that of the 1,600 companies that did share consolidations over 40 years between 1962 and 2001, they typically underperformed the broad market by 50 per cent on a risk-adjusted basis for three years after the reverse split.
No one knows if Bombardier's will work over the longer term. But it seems the company knew something had to be done. Hovering around $1 per share, the stock looks more like a call option on the prospect of a government bailout than a publicly-traded share. Boosting the price by 10 or 20 times makes it look like a stock again, and that puts a new veneer on the company.
The federal government needs to make sure it doesn't fall for it right away – or even worse, use it as an excuse to give money. A higher share price, coupled with Air Canada's new plane order, might make Bombardier look more appealing. But there are cracks in it. The reverse stock split is an accounting trick, and Air Canada's planes are reportedly to be purchased for cut-rate prices. Changing psychology is one thing, turning a struggling business around is another.