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Why This Junior Miner's "Reverse Split" Could Lead to Big Gains

We get lots of terrific questions from our readers. Some – like the dozens we received from you seeking profit plays on graphene – are turned into full-blown Private Briefing investment columns.

But others beg for specific answers from specific gurus – like this query about junior miner Aurcana Corp. (TSXV: AUN), Real Asset Returns Editor Peter Krauth's pick for the Private Briefing special report "The Seven Investments You Have to Make in 2013."

"Hey guys, Aurcana just announced plans for a "share-price consolidation.' What is this, exactly? What impact will it have on the stock price, both in the short-term and the long-term?" I recently purchased 3,000 shares at 79 cents each." — Patrick B.

Thanks for writing, Patrick. What the Vancouver-based Aurcana has done here is to announce a one-for-eight "reverse stock split." In other words, investors will get one "post-consolidation" share for every eight shares they have now.

So the 3,000 shares that our friend Patrick bought would become 375 post-consolidation shares.

At the same time, however, the value of those post-consolidation shares should be eight times the pre-split value.

Let's create an example using Patrick's position and purchase price to illustrate.

He bought 3,000 shares at 79 cents, meaning he spent $2,370 (excluding commissions). The reverse split would cut that position down to 375 shares (dividing by eight). But it should also boost the value of those shares by eight, meaning each one will be worth $6.32.

To show you that no value is lost, let's multiply the 375 shares by the $6.32 share price. The result: $2,370.

[In other words, 3,000 shares x 79 cents = $2,370 and 375 shares x $6.32 = $2,370.]

As Peter explains it: "The initial impact on the share price is to boost it by eight times.

In effect though, every shareholder will then have one-eighth the previous number of shares,

So, from an investment standpoint, it's pretty much a wash."

Peter said "pretty much" because he knows, as I do, that there's often a bit of "slippage" with reverse splits – perhaps because these transactions are often perceived as a sign of financial weakness.

In this case, however, Aurcana is a stock that Peter likes a lot.

"As you know, Bill, there are advantages to transactions like this one," Peter said. "The higher share price created by the reverse split will often qualify the stock for ownership by certain institutional investors. Many mutual and pension funds are restricted by charter from purchasing shares that are below a certain price (such as below $5 a share). The new, higher price should make the company more accessible to these investors."

Another advantage is that Aurcana may eventually list on another exchange – a possibility that Peter also acknowledged.

"My guess is that this exchange would be in the U.S.," he said. "That, too, will open up the possibilities for a large number of potential new shareholders, both retail and institutional."

Aurcana said as much, with company CEO Lenic Rodriguez stating that "after carefully considering Aurcana's growth and strategic objectives, we believe that a consolidation could provide significant benefits to the company and its shareholders. This change may open the door to a large base of potential new investors and will qualify the company for a possible dual listing on a U.S. or other major stock exchange. This is an important step in Aurcana's strategic efforts to become a senior silver producer."

In addition to the incentives listed by Peter, Aurcana detailed several other motivations behind the proposed reverse split. The company said that, while there are no guarantees, the transaction could help Aurcana:

  • Access a larger pool of investors which, in turn, would hopefully lead to an increase in trading volumes (making the stock more liquid).
  • Improve the market perception of its stock.
  • And align the number of shares outstanding with those of its peer companies.

The transaction has to be approved by both the TSX Venture Exchange and Aurcana's shareholders. If that happens, Aurcana's 467,157,647 issued and outstanding common shares would be reduced to 58,394,706 shares.

Although reverse splits are often viewed in a negative way by investors, the outcome can be quite positive, Peter noted.

"Don't forget that this is the exact same strategy used by Sandstorm Gold Ltd (TSE: SSL)," he said. "In May of last year, Sandstorm consolidated five for one, then by August listed on the NYSE. And we know how that turned out."

Indeed we do. Sandstorm was Peter's pick for our "Five Investments You Have to Make in 2012" special report.

After recommending the stock at a split-adjusted price of $6.20 a share on Dec. 23, 2011, the stock soared as much as 142% – helped out, as Peter noted, by the split and the dual listing that brought the stock to the U.S. exchange.

In fact, you should see what Peter's currently recommending in his Real Asset Returns portfolio. Check it out by clicking here.

[Editor's Note: We generally recommend that investors employ 25% "trailing stops" on all holdings. But in our "Seven Investments" report, Peter says to "Buy" Aurcana Corp. (TSXV: AUN) at the market, and use a 50% trailing stop. Be sure to observe position-sizing limits.]

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