Another InvestorPlace columnist, Mark Hake, recently wrote about New Zealand lingerie manufacturer Naked Brand Group (NASDAQ:NAKD). He noted that it has approximately 150 days to do a reverse split, in order to get NAKD stock back in compliance with Nasdaq’s rules.
If Naked Brand executes a 1-for-100 reverse split, its share price will go from 34 cents this morning to $34, well above penny-stock status. That will make the shares appear to be much more appealing. NAKD stock hasn’t traded above $5 for more than 30 days since the fall of 2013.
However, it’s important to remember that the split won’t change the company’s financials at all. Actually, it will merely reduce the number of shares that the company has outstanding. The reverse split is a visual mirage. Don’t be fooled by this kind of paper shuffling.
Naked’s Second Reverse Split
For those investors looking to make a quick buck off Naked’s low share price, or if you truly believe its business has a shot at rebounding in 2021 and beyond, it’s important to note that the impending reverse split is slated to be its second such split in 18 months.
On Dec. 19, 2019, the company did a 1-for-100 reverse split reducing the shares outstanding from 330.4 million to 3.3 million.
So, over 18 months, it diluted existing shareholders by selling approximately 231 million shares to reach 23 million shares as of the end of October.
A second 1-for-100 reverse split would reduce the number of shares outstanding to 3.95 million, at which time the company could start issuing tens of millions of more shares, starting the process all over again.
When Dilution Is Really Bad
Hey, when you’re Tesla (NASDAQ:TSLA) and your stock is trading near an all-time high, selling more stock and investing the proceeds is smart. With their stock prices below 34 cents per share, companies usually sell shares in order to survive.
Hake points out that the company is looking to live to fight another day.
“On Nov. 10, the company filed a Form 6-K with the SEC that detailed its struggle to stay alive as of the first half the year ending July 31, 2020. Red ink is everywhere. People just simply aren’t in the mood to buy lingerie, at least like they used to,” Hake wrote in his Jan. 6 article.
“But, the good news is the company seems to be ‘right-sizing.’ It has dramatically cut costs, applied for government aid, converted debt into shares and raised equity. In fact, for the six months to July 31, it reported a small positive cash flow from operations (CFFO) and had NZD 3.8 million in cash.”
In case you’re wondering, NZD 3.8 million is worth $2.8 million U.S. dollars.
Hake goes on to use probability analysis to predict the future price of NAKD stock. You might want to read his analysis.
Anyway, based on the three scenarios that Hake analyzed, he suggests that the expected return of the shares over the next 12-24 months is at least 20% and possibly as high as 120% or more.
So, if you’re a gambler and believe in probability analysis, the risks of NAKD stock at 34 cents per share are pretty low.
The Bottom Line
In November, Naked Brand said that its sales fell 18% year-over-year from January to June to $34.6 million, while its EBITDA loss, excluding certain items, fell by 87% in the same period to just $1.3 million. Equally important, its gross margin during the period was 40.9%, 7.7 percentage points higher than a year earlier.
So, yes, things aren’t worsening for the company.
However, when I last wrote about Naked Brand, I wondered why its stock was even trading on Nasdaq. It really should be a private company where it can fix what ails it behind closed doors.
Hake’s probability analysis might suggest it’s got a shot. But its likely issuing of additional shares in the future is sure to reduce those odds.
I wouldn’t touch NAKD stock with a ten-foot pole.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.