Penny Stock Mergers and Amalgamations - dummies

Penny Stock Mergers and Amalgamations

By Peter Leeds

Penny stock companies can merge together, or “amalgamate,” which simply involves becoming one entity. They may combine employees, facilities, executives, and products, and potentially benefit from the increase in capabilities, product offerings, and financings.

Mergers are unlike acquisitions because mergers involve two businesses voluntarily combining. The merging companies are not being swallowed up against their will, but rather are coming together to benefit from improved capabilities, enhanced economies of scale, and an increased skill set. While a takeover typically results in the target company becoming a part of the buyer, companies that merge tend to maintain most of their presence and operations.

Penny stocks can reap many benefits from merging with another penny stock or even with a larger company. Assuming the amalgamation makes strategic sense, the benefits can include:

  • Economies of scale: If the merger increases the number of products produced, or total revenues generated, a company can decrease expenses on a per-item or per-dollar basis. The right merger can also significantly decrease fulfillment costs, which are the expenses required to provide products or services.

  • Increased takeover defense: Larger companies are harder to take over. By growing through mergers, a penny stock becomes that much bigger, and as such, that much more difficult to be bought out.

  • Consolidating operations: Whether bringing all the administrative functions under one roof, or running the sales and production in a single location, there can be significant advantages to both companies by consolidating their operations.

  • Expanded offerings: Often two companies in a similar industry but with different specialties can come together to provide a more complete solution for their customers. For example, a printing company that is also able to offer design services becomes more attractive to its prospects.

  • Accretive revenues and earnings: When a business is already generating earnings, or bringing in revenues, those earnings and revenues go to the postmerger company.

Penny stock splits and reverse splits

Sometimes a company can decide to split its shares, which simply involves turning the existing shares into a greater number, based on any multiple it chooses. For example, a two-for-one split would turn every share into two shares, while a four-for-one split would turn every share into four.

A split results in a greater total number of shares available, while each share is then traded at a lower price. Consider a company with 10 million shares outstanding, trading at $50 each. After a 2-for-1 split, there would be 20 million shares, with each being worth half as much, or $25 in our example.

Companies split their shares to keep the prices lower, usually after a long-term and significant price increase. The split makes the stock more attainable by smaller investors and may bring the share price more in line with competitors and other companies in the peer group. Splits also widen the shareholder base by increasing the total number of shares available to investors.

Often after a split, the shares continue to rise in price. The stock has already been doing very well, and the split signals that success to investors.

Share splits are very rare among penny stocks, because most lower-priced shares are not interested in trading at even lower prices. With penny stocks, the exact opposite of the split, called a reverse split or share consolidation, is quite common.

Reverse splits combine the existing shares together by whatever ratio the company decides. A $1 stock with 50 million shares outstanding could conduct a 1-for-5 consolidation, which would result in that company having 10 million shares trading at $5 each.

Typically, after a reverse split, the shares continue to fall in price. Although the shares are, relatively speaking, higher in price, they generally continue to slide to lower relative prices. For example, shares may consolidate on a one-for-five basis, bringing their price up to six dollars, but they will start trading lower. The slide takes place because companies having experienced falling stock prices usually conduct reverse splits.

Why you don’t see splits in low-priced shares

Penny stocks don’t split their shares because there are usually too many shares out already and the price is already too low.

A typical penny stock company may be trading at 30¢ per share, with 200 million shares outstanding. If it were to split 3 for 1, the share price would lower to 10¢ and the number of outstanding shares would increase to 600 million. The end result would be a very low share price and an excessive amount of shares available, both of which make the company less compelling to investors.

Companies want to seem more legitimate, and higher share prices create that appearance. They also want to keep their outstanding shares under control, which means that they don’t want to be splitting and multiplying them on the market.

Why reverse splits are common in penny stocks

Penny stock companies consolidate their shares more frequently than any other size of investment. They may take this step to achieve any of the following goals:

  • Maintain or gain a stock market listing. If a company needs a minimum share price to be listed on their exchange but fall below that threshold, it could do a reverse split to bring the share price higher. For example, a 25¢ stock could consolidate 1 for 10, bringing the theoretical price to $2.50 and reducing the number of outstanding shares to one-tenth of the original amount.

  • Increase perceived legitimacy. Higher-priced stocks typically imply higher quality companies. Although share price really has nothing to do with the success or prospects of the business, a higher prices does look better to investors and clients.

  • Decrease outstanding shares. Many penny stocks have far too many shares available because of their tendency to continually issue new stock to raise money. One way to quickly reduce the outstanding shares is to consolidate.