GM Wipes Out Shareholder Equity

by Dual Income No Kids on May 6, 2009 · 0 comments

Hi All,

You’ve probably seen the headlines by now. General Motors is planning a reverse stock split.

A reverse stock split is essentially a procedure to reduce the number of shares a company has outstanding. For example, assume a company has 10 million shares outstanding and each share is valued at 10 dollars. If the company engineers a reverse split of 10 for 1, the ending number of shares outstanding will be 1 million and each share will be worth $100. Reverse splits are usually done by companies who wish to raise the price of their shares. Unfortunately, the are often done by firms who have weak financial positions.

Now, back to GM. GM filed a Schedule 14C to notify the SEC of their action. The 14C announced the companies intention to do the following. As taken directly from the SEC filing:

1) “effect a 1-for-100 reverse stock split of GM common stock”.

2) “increase the number of authorized shares of GM common stock to 62 billion shares”

3) “the U.S. Treasury (or its designee) would own at least 50% of the aggregate amount of pro forma outstanding GM common stock”

4)”If the restructuring as currently contemplated occurs, there will be very substantial dilution to existing holders of GM common stock. After the restructuring, as currently contemplated…existing holders of GM common stock would hold approximately 1% of the outstanding GM common stock.”

So, what does all this mean? It means that if you own shares in General Motors, your equity stake in the company is going to obliterated. Assuming the shares are worth 1.85, after the split, they’ll be worth .0185, about two cents.

The story is getting a lot of coverage, but frankly, I’m impressed at the sheer loss of value. The company was trading at 87 dollars in 1999, thats a loss of over 53 billion in equity alone on the companies current 610 million outstanding shares. Even with the huge numbers being batted around in the headlines these days, its still an impressive destruction of wealth.

At this point you are probably well justified in selling your GM shares. They won’t build your wealth, and at best you will “only” lose some of the wealth you invested into the shares.

Check out the Schedule 14C here.

Best,

James

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