Voluntary Delisting From NASDAQ To Find Profits

Initial public offerings (IPOs) have become one of the most exciting events on Wall Street after the dotcom heyday created more paper millionaires than any other time in history. Even though IPOs continue to dominate the press, many small investors are instead beginning to discover the vast opportunities available in delistings, which are the opposite type of transaction.

How Do Delistings Work?

Delistings occur when companies decide to delist their stock from stock exchanges in a move to privatize or simply move to the over-the-counter (OTC) markets.

This process occurs in one of two ways:

  1. Voluntary Delistings occur when a company decides that it would like to purchase all of its shares or move to an OTC market while in full compliance with the exchanges. Usually, these are the types of delistings that investors should carefully watch.
  2. Forced Delistings occur when a company is forced to delist itself from an exchange because it fails to meet the listing requirements mandated by the exchange. Typically, companies are notified 30 days before being delisted. Share prices may plunge as a result.

Advantages and Disadvantages of Voluntary Delisting

Companies may decide to deregister for a variety of reasons that can be either good or bad for shareholders.

A few of the most common reasons include:

  • Capital Savings - The costs of being a publicly traded company are substantial and are occasionally difficult to justify with a low market capitalization, especially after Sarbanes-Oxley laws called for increased disclosures. As a result, deregistering can save a company millions and reward shareholders with a higher net income and earnings per share (EPS).
  • Strategic Move - Company shares may be trading below intrinsic value, compelling the company to acquire its own shares as a strategic move. This typically results in shareholders being rewarded with substantial returns over the short term.
  • Regulatory Concerns - Stock exchanges such as the Nasdaq and New York Stock Exchange have minimum requirements for companies to remain listed. If a company does not meet those requirements, it may be forced to delist itself. Causes for delisting may include failure to file timely financial reports, lower-than-required stock price, or insufficient market capitalization. In the end, companies can have a clear bottom-line incentive for delisting their stock from public exchanges — it's not necessarily a bad thing!

How to Profit from Delistings

Delistings may make sense for companies, but how can the average investor take advantage of the situation? Well, the best opportunities are found in companies that voluntarily delist to go private and cash out their shareholders. Typically, this is because management is confident that the company is undervalued or could save substantial money by operating as a private enterprise. These efforts to cash out shareholders can often yield substantial returns to investors willing to do a little homework.

The key to this strategy is finding instances where tiny companies are trying to "cheat" the Securities and Exchange Commission (SEC). The SEC mandates that companies file paperwork if they choose to go private, but can avoid the extra efforts if they have fewer than 300 shareholders. Consequently, small companies often issue large reverse stock splits to reduce their number of shareholders and pay off the remaining shareholders holding less than that amount with cash compensation.

Fortunately, many institutional investors avoid these stocks due to the lack of liquidity and risk associated with these deals. However, small shareholders can often net a handsome profit from the strategy.

For example, let's say company XYZ issued a 600:1 reverse stock split and then repurchased its shares at $5. Incredibly, shares traded at $4.24, well below the repurchase price after the stock split. This occurred despite the plan to privatize, which was being considered as a result of the stock's lack of liquidity and the fact that it wasn't covered heavily by any institutions. Not many individual investors would turn down nearly 18 percent gains in a matter of weeks!

Shareholders may also find other opportunities in obscure payoffs offered in privatization deals. Sometimes, companies will offer rights offerings, warrants, bonds, convertible securities or preferred stock to entice shareholders to tender their shares in a move to privatize. Unfortunately, many of these offers are restricted to larger shareholders who are able to bargain more effectively.

Finding Opportunities

All significant corporate events must be recorded in filings with the SEC. As a result, investors can quickly find delisting opportunities in SEC filings that are publicly available through SEC's EDGAR database.

Delistings are found in three types of SEC filings:

  • 8-K Current Events - 8-K filings tell investors when and why the company is delisting and are often the first public notification of such intent. This includes the initial announcements of stock splits, which may be a precursor to privatization in smaller companies.
  • Schedule 14A Proxy Statements - Proxy statements enable shareholders to vote on whether to go through with delisting (if it is voluntary). This usually occurs during a going-private transaction and may also be the first public notification of such intent.
  • S-1/F-1 Registration Statements - These filings detail any new securities being issued as a result of delisting, which may include preferred stock, bonds, warrants or securities in the private company being formed as a result.

The Bottom Line

In the end, delistings can provide profitable investment opportunities or lose major money for shareholders. Everything depends on the motivations behind the privatization, the size of the company and terms of the offer. Investors willing to invest the time and effort to find and research opportunities may uncover some gems for their portfolios that can perform extremely well in the short term.

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