April 27, 2012 3:59 pm

RBS share move raises doubts

This week Royal Bank of Scotland, which is four-fifths owned by UK taxpayers following the government bailout in 2008, announced plans to throw off the trauma of the past four years and transform its share price in one fell swoop from 23p to £2.30.

If approved by investors at the annual meeting next month, the bank will swap 10 shares for one.

However, the move has left analysts scratching their heads about what it really does for shareholders.

In the US, many companies have consolidated shares for fear of share prices falling below regulatory thresholds, which would force them to delist. In Britain, most share mergers are done by deadbeat stocks whose shares have fallen below a penny. It is highly unusual among big UK companies, say market watchers.

Some research suggests consolidations improve the liquidity of shares while cutting trading activity and volatility. But academics warn the evidence is limited.

RBS’ arguments for merging its shares centre round the view that most FTSE stocks trade between £2 and £4 and hopes the move will help to anchor down the RBS share price. “The company currently has a very large number of issued ordinary shares and at the current level small absolute movements in the share price result in large percentage movements resulting in consolidation volatility,” RBS says.

“That is wishful thinking,” says Paul Marsh, emeritus professor at the London Business School. He points out most share prices move in fractions of a penny and says RBS shares will be just as volatile at £2 as they are at 20p.

“Volatility will fall if there are fundamental improvements in the business and further de-risking, but not because of the consolidation. This could be a distraction – and the undisclosed administrative costs of doing this could be quite large”.

Veterans of the UK stock market are similarly sceptical. “There is no economic rationale. It is cosmetic,” says one leading institutional investor. “Boards, particularly of big companies, don’t like their shares being described as penny stocks. But the benefits are merely emotional.” And like cosmetic surgery, the costs may outweigh the benefits, he adds.

Nonetheless, RBS is not the only financial group, bailed out by its government, that has now decided to consolidate its share count.

Last month, Ageas, the insurer created from Fortis, the failed Belgian-Dutch insurer, announced plans to turn 10 shares into one. The reason: to simplify the group’s legal and regulatory structure and merge its Netherlands and Belgian businesses.

RBS’ plans come almost a year after Citigroup in the US also completed a 10 for one share swap, transforming the price from $4.50 into $45.

The difference, though, between RBS and Citi is that RBS’ shares are tightly held, with 82 per cent in government hands, whereas Citi’s shares were very liquid, say market experts.

Citi is an outlier, say analysts at Investment Technology Group in the US. “No other common stock of similar liquidity has experienced a reverse split with ratio 5:1 or more in recent US history.”

Citi’s rationale was to normalise the group’s share count relative to peers, and to attract a broader group of investors. It thought, too, a higher stock price would reduce transaction costs for both institutional and retail investors and reduce high-frequency trading and volatility.

Observers agreed that cutting the number of shares would cut trading volumes back to more normal market levels. A year ago, the American bank’s share of total US trading volumes was about 6 per cent. By July, stock market analysts noted that daily trading volumes in Citi shares, particularly big trades “off exchange”, had fallen sharply.

The ITG analysts say the benefits for investors are nuanced. For small trades in Citi shares, the spreads – the difference between the price for buying and selling shares and described by ITG as “a key measure of market quality” – tightened, therefore lowering investors’ costs. However, spreads widened and costs rose for larger trades.

Vikram Pandit, chief executive, this month declared the consolidation a success. “Volatility and high-frequency trading is down, with more and more investors in our company taking the long view.”

But RBS’ hopes of seeing a similar change to its shareholder register will only be realised when the UK government sells some or all of its shares in the British bank.

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