Can a falling stock price kill an otherwise viable company?
With technology giants such as Cisco Systems, Oracle and Sun Microsystems tumbling toward $10 a share, the question is far from academic. By itself, a low share price shouldn’t cripple a good business, experts say.
However, a swooning stock price can hasten the demise of a faltering company and create serious obstacles for even a strong one. Wall Street derisively refers to stocks under $10 as “single digit midgets,” suggesting it gets harder to take a company seriously when its share price falls below that threshold.
On a tangible level, a severely depressed stock means it becomes tougher to raise capital by selling shares to the public. What’s more, employees are demoralized as their options values fade, and acquisitions get more expensive as a company’s chief currency for takeovers — its own stock– loses altitude.
Beyond that, low-priced stocks tend to fall off Wall Street’s radar. Justifiably or not, traders and money managers may view them as speculative and not worth the risk.
“The stock price sends a signal about whether a company is investment grade,” said William H. Gross, chief strategist at Pacific Investment Management Co. “Something about single digits says, `Maybe…'”
No matter how reluctant investors may seem to buy tech shares today, of course, there is still too much greed on Wall Street to allow a company to remain badly undervalued for long. Stock market doldrums often give way to waves of leveraged buyouts in which investment groups borrow money to buy entire companies that they consider bargain-priced.
At the extreme, shareholders may demand that a company be liquidated and its assets sold for cash if it becomes obvious that the stock value is lower than the breakup value.
Yet for some tech giants today, their low share prices still don’t signify “cheap” businesses, analysts note. Because of the companies’ massive number of shares outstanding, the market capitalizations of Cisco, Sun and others remain huge, and their stock price-to-earnings ratios still are historically high, experts say.
But their sinking share prices may nonetheless create an air of desperation. For smaller tech firms, one practical concern is that when a stock falls below $5, it is no longer “marginable” at most brokerages. That is, it is no longer valid collateral for margin loans — money that brokerages lend customers to buy stocks.
When a stock becomes unmarginable, the investor may be forced to sell shares to raise cash collateral. Multiplied by thousands of margin customers, such an event can create extreme downward pressure on stock prices.
Lucent Technologies, one of America’s most widely held stocks, is now within hailing distance of that no-man’s land. On Monday, Lucent closed at a multiyear low of $6.75.
Anemic stock performance also can put companies at a disadvantage in day-to-day business dealings, noted Richard Cripps, strategist at brokerage Legg Mason.
“It creates a perception that causes customers and vendors to ask questions and demand terms that add to survivability concerns,” Cripps said.
Companies such as Cisco, whose strategy has been to use its high-valued stock to buy attractive smaller companies, may find it impossible to maintain their explosive growth, analysts said.
Although harder to pin down, questions of image and investor psychology can have an impact on the business and the future of the stock as well. An economist would say it shouldn’t matter whether you hold 100 shares of a $10 stock, 10 shares of a $100 stock or one share of a $1,000 stock. The total value is still $1,000.
Yet it does make a psychological difference, which is why when their shares rally past $100, most companies use stock splits to bring the price back down into double digits.
Similarly, when foreign companies list their stock on U.S. exchanges, they are aware that a low price may signal “low quality,” while a high price may signal “too expensive,” said Meir Statman, a professor at Santa Clara University and expert in investor psychology.
Such companies get around the problem by creating “units” of either fractional shares or bundled shares designed to trade at around the same price as American stocks in the same industry.
One way for a company to boost a beaten-down stock is to buy some portion of it back. After the 1987 market crash, many companies scored big for shareholders buying back stock that had fallen to bargain levels, noted economist Paul Kasriel of Northern Trust.
But that performance will be hard to repeat today because so many firms pursued buybacks in recent years, when their shares were at stratospheric levels. Now, when their shares may be legitimately undervalued, they lack the cash to buy, Kasriel said.
If a single-digit price is a problem, it might seem logical for firms to announce reverse stock splits, issuing one new share of stock for every two or three shares investors hold. The effect would be to double or triple the per-share price while keeping the total value the same.
Logical perhaps, but potentially suicidal: Reverse splits tend to be the province of obscure companies with marginal business prospects. Such a move by a highly visible company could send a signal of distress that would instantly tarnish its reputation on Wall Street.
“It’s not an option for most companies,” Cripps said.
On the other hand, the way the market has been going, “we may have to rethink that rule,” he said.
SHRINKING TECH SHARES
As technology company share prices dwindle, they risk falling to levels at which many investors no longer pay attention. Here’s a look at 15 key tech and telecom shares that are nearing the $10 price threshold or have fallen below it.
52-WEEK MONDAY % CHANGE
STOCK HIGH CLOSE FROM HIGH
%%
Yahoo! $173.00 $15.64 -91%
JDS Uniphase 140.50 15.27 -89
Cisco 77.00 14.49 -81
Oracle 46.47 14.05 -70
Nextel 75.19 13.54 -82
Sun 64.69 13.04 -80
Motorola 52.65 11.50 -78
Amazon.com 68.63 11.18 -84
RealNetworks 59.50 7.33 -88
Lucent 67.19 6.75 -90
Palm 67.38 6.48 -90
Xerox 29.31 5.27 -82
Ariba 173.50 5.06 -97
3Com 75.00 4.60 -94
CMGI 109.94 1.91 -98
%%
Sources: Los Angeles Times, Reuters
