Reverse stock splits tell you a lot about a company’s fortunes and not much of it is good.
So the decision by Babylon Holdings Ltd., the New York-listed, UK-based telehealth company, (NYSE:BBLN) to approve a reverse split at its annual meeting is a sign that things aren’t going well at all.
Babylon may rank among the worst initial public offerings (IPOs) of 2021. Last October it issued shares at $9. [All figures in US dollars.] They were trading at 63 cents at the time of writing for a decline of 93%.
Babylon went public at exactly the wrong time, just as the love affair with telehealth stocks faded. Then interest rates started to rise, along with inflation and the global economy has contracted following Russia’s invasion of the Ukraine.
The situation highlights the risks inherent in IPOs. They come to market at the best time for insiders to cash out, often at the peak of their economic cycle. The good news is out, while the bad may be hidden. You don’t much about the company, so it is hard to know whether the product or service is really better than others like it.
Babylon was founded in 2013 and is a telehealth pioneer, offering services that connect doctors, patients and pharmacists via their phones or computers. It also sells software that helps medical offices with records and bookings management.
Babylon operates in 15 countries with partners that include the British National Health Service, Canadian telecom leader Telus Corp., Microsoft Inc. and American software company Palantir Technologies Inc.
The Sept. 14 meeting authorized the company’s board to combine its shares in a range from 1 new share for between 15 to 25 old ones. The information about the split is also contained in a monthly filing with the US Securities Exchange Commision.
If you own 1,000 Babylon shares and the reverse split is 25-to-1, you would receive 40 new ones. At the 15-to-1 rate you would receive 66.6 shares.
Based on a 63-cent price, the new shares would be worth $15.75 at 25-to-1 and $9.45 each at 15-to-1.
Do reverse splits work?
Reverse stock splits do not add any value to a company. They reduce the number of shares outstanding and give each share a higher value. Such things as earnings per share are adjusted proportionally.
So why do it?
A big reason is to avoid delisting from a stock exchange. One of the delisting triggers for the New York Stock Exchange can be if a share price falls below $1 for 30 consecutive trading days – roughly six weeks. Babylon last closed above $1 per share on Aug. 5.
Another reason is to make the company seem more substantial and so attract more investors. Penny stocks are seen as gambles rather than investments. Some pension and mutual funds cannot invest in companies with share prices below $5.
Nor do reverse splits usually do much to turn a company’s fortunes around. General Electric Corp. (NYSE: GE) did an 8-to-1 reverse split in July 2021, taking a US $12.50 stock to $100. At the current price of $66.39, it has lost 34% of its value since then.
US banking company Citigroup Inc. did a 10-to-1 reverse split in 2011, taking a $5 stock to $50. Citgroup was trading below that level at $48 this week, more than a decade later.
What’s gone wrong at Babylon?
IPOs are always risky, though Babylon would have seemed to be a good bet. It has been in business for more than a decade. It is a telehealth pioneer, just as this form of medical care takes off. Its message has been consistent.
Babylon reported second quarter revenue of $265 million on Aug. 9 almost 5 times greater than the same period in 2021. Its $157.1 million loss compares with $69 million, a year ago. As a percentage of revenue, the loss fell by more than half as it adds clients and gets synergies from investments in technology platforms.
Babylon reiterated its forecast that revenue will hit $1 billion this year, three times greater than 2021. Losses as a percentage of revenue will continue to fall. It reiterated its forecast of profitability by 2025.
CEO Ali Parsa said in a conference call that its unfortunate IPO timing, use of a Special Purpose Acquisition Vehicle (SPAC) vehicle to do so and the unforgiving climate for growth stocks has been a perfect storm.
Mr. Parsa said the anti-SPAC backlash has been acute. SPACs are shell companies set up with the sole purpose of raising money more cheaply through an IPO. Post-IPO many SPACs missed revenue and profit projections and been accused of a lack of transparency.
In the call, Mr. Parsa compared Babylon to Amazon Inc. (NDQ:AMZN) in 2001 when at the height of the dotcom crash its shares fell from US $113 to $6, a decline of 90%, not dissimilar to Babylon’s.
“When [Jeff] Bezos was asked about that experience he said he always knew that the stock wasn’t the company and the company wasn’t the stock.”
A week after it reported its earnings, Babylon’s stock was halted on rumours it is in talks to be acquired and is considering taking itself private. The company denied the rumours.
Adam Mayers is a contributing editor to the Internet Wealth Builder investment newsletter and a contributor to the Globe Advisor section of the Globe and Mail’s Report on Business.