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Created on 14.08.2019

Splits, reverse splits, spin-offs: how capital decisions have an impact on your custody account

Corporate actions refer to measures taken by a company that alter its capital structure. This could be a capital increase, a split or a swap. “Corporate actions” are very important for shareholders: anyone familiar with basic capital decisions will also know how they affect their own investments, and will be able to take appropriate action.

The decisions public limited companies make concerning their capital have a major impact on stock exchange activity. The article “Corporate actions: capital increases and reductions” has information on two of the four corporate actions that public limited companies can take. We will explain more corporate actions here, as well as their effects on investors:

Splits: how they work

Splits are when the number of shares  increases, and the face value per share decreases. What this means is the share capital of the company stays the same – it’s just the number of shares in circulation that increases. For shareholders, this could mean something like this: If someone has 100 shares at a face value of CHF 100 each and there is a 1:2 split, they will end up with 200 shares with a face value of CHF 50 each.

Companies can decide to split shares if they are too “heavy”. If a share is too “heavy”, this means the value of that share is too high. For instance, if the value of a share increases from CHF 100 to CHF 10,000. High prices may provide a degree of exclusivity, but it is bad for a company’s liquidity seeing as such high prices will make the shares less appealing to small-scale investors.

Splits: the impact on shareholders

If there is a split, the shareholders do not need to do anything – the new shares are transferred into their custody accounts automatically. This means a simple split does not have any effect on taxes as long as the shares are the same type. The historical prices of the share are adjusted automatically to stop the chart experiencing a “false” drop in price, which could mislead investors. 

Reverse splits: how they work

Reverse splits, as the name implies, are the opposite of splits. A reverse split is where the number of shares is reduced, and the face value of each share is increased. What this means is the share capital of the company stays the same in the event of a reverse split – it’s just the number of shares in circulation that decreases. For investors, this means the following: If someone has 100 shares, each with a face value of CHF 100, and there a 2:1 reverse split, they will have 50 shares with a face value of CHF 200.

A reverse split is performed when a share is too “light”, in other words if its price is particularly low. Just as having overly “heavy” shares in circulation is unappealing to companies, overly “light” shares can also be problematic. By performing a reverse split, the company can make the shares appear higher in value. If a share falls below its face value, it becomes necessary to issue new shares to improve capitalization purely due to stock corporation law. Reverse splits connected to capital reductions, however, are most common in instances of company restructuring. The reverse split requires the approval of the General Meeting. 

Reverse splits: the impact on shareholders

Even in the event of a reverse split, there is still no need for you to take any action as a shareholder. The position in your custody account is adjusted automatically. Your new shares may gain a new International Securities Identification Number (ISIN). If this happens, the new, reverse-split shares are registered with the new ISIN, and the old shares are derecognised. The market price of the shares in the custody account remains unchanged. Just as with a split, all the necessary adjustments are made automatically. 

Spin-offs: here’s how they work

When a spin-off occurs, a new company comes into being: a business unit is separated from an existing company, or a subsidiary is separated from a holding company. This leads to the creation of an independent company that is listed on the stock exchange. In order to separate a spin-off from a holding company, the following is required:

  • Analysts ascertain the market value of the subsidiary
  • The value ascertained corresponds to that of the newly formed company
  • The value of the parent company decreases by this value

If a holding company and its subsidiary have a market value of CHF 1 billion and CHF 100 million respectively, the parent company will be worth CHF 900 million after the spin-off has taken place, the new company CHF 100 million.

The same applies if a business unit spins off into its own independent company. In order to exist as an independent company, the unit in question must be restructured beforehand. The effective value of both companies, however, is only ascertained once their shares start being traded on the stock market.

There are four main reasons for a spin-off.

  • Incompatible strategies: the business unit/subsidiary company is no longer compatible with the parent company’s strategy, or it is not proving profitable.
  • Capital requirements: the business unit or the subsidiary requires fresh capital. A separate stock market flotation can help provide this.
  • Merger: there are plans for the business unit or subsidiary to be merged with another company.
  • Shareholder value: the plan is for the business unit or subsidiary to stay part of the company, but it is going to be listed separately on the stock exchange to generate more shareholder value.

Spin-offs: the impact on shareholders

To compensate for shareholders relinquishing some of their shares, when a spin-off occurs they receive the right to buy the new company’s shares, or they may even obtain them for free. Investors that do not exercise this right can sell this purchase right on the stock market. This is known as subscription rights trading. It is crucial shareholders are not disadvantaged financially or legally when a spin-off occurs, regardless of whether the new shares are given away for free or subscription rights are purchased. 

If you know your stuff, you’ll reap the rewards

Anyone trading on the stock exchange should know exactly what corporate actions affect a company’s capital structure, as well as what impact they can have on the investor’s custody account. Splits, reverse splits and spin-offs may sound like abstract theories, but they can affect investors themselves only too quickly. Anyone with a company’s shares in their portfolio who goes on to announce a split, a reverse split or a spin-off would do well to learn all about whatever corporate action it is. This way, they will be able to make a decision on whether they wish to remain invested to the same degree, or (e.g. in the event of a spin-off) exercise subscription rights. Even if these corporate actions do not have a direct effect on the value of an investor’s personal portfolio, they do come with economic and financial considerations that may be relevant to the future of the company. PostFinance customers considering corporate actions can find information online about the different types of transaction by going to the e-trading portal.

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