Is a reverse split ever a good thing? China Recycling Energy (CREG)

For every rule there is an exception, or so the story goes.  That is never more true than in the public markets.  No one single indicator, whether fundamental or technical, is right 100% all the time.  It couldn't be, the market couldn't function if it was.  

If, for example, insider selling was "always" bad and was guaranteed to lead to a falling share price, then pretty much everyone would start jumping ship whenever a company's stock reported insider sales.  But if everyone is selling, that means there's no buyers.  Its that old analogy I use all the time about a football game with both teams lining up on the same side of the ball, the game wouldn't work, and neither would the markets.

Which brings me to the subject of reverse splits.  Like insider selling, consolidations are generally considered to be negative events, and its easy to understand why.  Share consolidations are most often the result of a falling share price, and are usually employed so that a company can maintain its listing on an exchange like the Nasdaq or NYSE.  

A reverse split cures the deficiency in the share price, by multiplying the PPS by 10, or 20 or whatever ratio is decided upon.  But it only treats a symptom, not the actual disease.  A stock price falls because of a lack of investor confidence.  While consolidating the number of shares fixes, at least temporarily, the share price requirement to remain listed on a senior exchange, it does nothing in of itself to fix the investor sentiment which caused the share price to fall in the first place.

Shares of China Recycling Energy (CREG) were consolidated 10:1 on May 26th after having fallen all the way to 26 cents.  The reverse split had the effect of immediately raising the PPS over the Nasdaq's required level of $1.00 which, if maintained for 10 consecutive days, will put the company back in compliance with the rules of the exchange.  Which leaves two days as of this writing.

I think these two days could prove interesting.  I'll explain why at the end.

I have been holding CREG since the summer of 2013, for almost 3 years.  And while I did sell a small number of shares when it spiked up around $5 in that same year, I held onto the vast majority.  

How did CREG come to be on my radar?  

I found China Recycling when researching small cap holdings of the Carlyle Group.  Years ago, back around 2000, I had done the same thing, seeing what publicly traded companies Carlyle held.  For those unfamiliar Carlyle is a who's who of conservative politics, with luminaries such as Reagan National Security advisor Frank Carlucci and George H.W. Bush's Secretary of State James Baker having been listed as board members.  In fact George Bush the elder reportedly did consulting work for them after serving as President.

Back in 2000 or 2001 I came across a company called Equinix trading under the symbol EQIX which was held in one of Carlyle's funds.  I invested in it and did very well.  After taking a large gain it also did a reverse split, in 2002, at a ratio of 32:1.  I bought in again after that reverse split but I didn't have the fortitude to hold on and eventually bailed at a loss.  Seeing where EQIX is trading now, for obvious reasons, I regret my decision.

But that's enough ancient history, besides its painful to remember :-)

So what has caused CREG's share price to languish so incredibly?  It was trading (as mentioned) up around $5 as recently as 2013, and fell to less than 30 cents necessitating the 10:1 consolidation.  

Frankly....I don't know, I can only guess.  I know I don't write much about fundamentals on this blog, viewing it as old information which is already "priced in" to a company's market capitalization.  But for those who are big on fundamentals CREG's don't look bad at all.   Post reverse the company is earnings positive with EPS listed as $1.78 as per WSJ.com. That puts their PE ratio at less than 1.5 as per the same site.  (Wall Street Journal Quote for CREG)

The first word in their company name might explain the low valuation however, that being China. After stories like Sino-Forest investors are justifiably cautious about Chinese companies.  But frankly, I believe there is more to it than that.

I wouldn't be the first person to see a stock plummet, and then to blame it on manipulation, but that is what I am going to suggest as a possibility.  Short selling is a legitimate market activity, and CREG has not been immune.  According to Nasdaq's site the number of shares short was just over 250K as of May 13th 2016.  I am assuming that number to be accurate  and split adjusted, which would have put it around 2.5 million prior to the share consolidation.

That's not a huge number certainly, with 8.3 million shares listed as outstanding its only about 3% of the total. Last year however the number, (before the share consolidation) was up around 5 million. If you look at CREG's volumes over the past 2-3 years, that's a lot considering there were many days the stock didn't even trade 10,000 shares.  (Price/Volume History as per Yahoo Finance)

Another point I should mention about Carlyle, which is currently (as per Nasdaq's site) listed as CREG's largest institutional shareholder with a little over 500,000 shares as of March 31st 2016, or over 5,000,000 pre-split.  Carlyle used to own millions more, but over the past 2 years has been selling.  In the last 3 months Nasdaq reports them having sold a little over 7% of their then remaining holdings.  But the fact they have maintained what I consider a still sizable position has me encouraged.  They had a deal in place some time (1 year or more) ago to sell all their holdings, but apparently it fell through.

To be clear, I am not recommending an investment in CREG, I am just putting this out there for anyone interested in reading.  My history with this stock, after all, is hardly stellar....quite the opposite. But that old saying about a broken clock being right twice a day, well maybe its time for the hands on CREG's clock to come around to a bullish hour.

After the 10:1 reverse CREG behaved as might be expected, it tanked.  Remember what I wrote about a share consolidation treating a symptom and not the disease?  Just two days after the reverse the PPS fell all the way from $2.60 to $2.00...almost a 25% drop.  But since then its rebounded, hitting 2.60 again inter day on June 7th and closing at $2.59

So why do I think the trading over the next couple of days could prove interesting?

My thesis, for lack of a better word, is that CREG has been the target of smart money accumulation, by parties that are not just "smart" but that have incredibly deep pockets as well.  That's what I'm gambling on.  EQIX all those years back saw similar swings and an even bigger reverse split.  And look where it is now.

I use the word "gambling" on purpose, because that is exactly what it is.  If I was 100% certain that CREG was going to follow the same path as EQIX and be worth hundreds of dollars per share in the coming years, I wouldn't be writing about it on a blog.  No, I would be taking out the equity in my home, my cars, maxing out my line of credit....I'd be buying every share I could afford.  But I'm not sure.

But if my gamble does end up being right, then these next two days represent a crucial time for CREG's share price as it must close over $1.00 on each of June 8th and 9th to be back in compliance with the rules of the Nasdaq exchange and to avoid being relegated to the OTCBB.  With that reality in place, and with any remaining retail investors (who knows I might be the last one) being notoriously price sensitive, then the PPS falling anywhere close to that $1 mark could conceivably shake free a good number of whatever shares remain in retail "dumb money" hands.  

I think you can probably guess what my intention is if that happens.