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I have been asked no question more than "will NeoStem (NASDAQ:NBS) reverse its stock?" On Friday, the company made the decision to split its stock, one for 10, and in my opinion, this is the first step in seeing a great deal of value added to the company.

What Is A Reverse Split?

Seeking Alpha contributor Amy Baldwin was the first to present the idea that NeoStem might in fact split its stock, and that it could be the next catalyst to push shares higher.

In her article, she showed three different stocks: Beazer Homes (NYSE:BZH), Flagstar Bancorp (FBC) and Cyclacel Pharmaceuticals (NASDAQ:CYCC).

Beazer homes completed a 1:5 reverse split taking its stock from $3.48 to $17.40. Then, it trended higher to over $20 in the weeks that followed.

Flagstar Bancorp did a 1:10 reverse split, taking its stock from $1.10 to $11.00. However, it then rallied until reaching $20 in the two months that followed.

Lastly, Cyclacel reversed its stock from $0.51 to $3.50, and then surpassed $8 a couple months later.

The moral of the story is that more times than not, a reverse split pushes stocks higher. Now, just to be clear, a reverse split does not in any way add one penny of value to a company. Instead, it is the process of lowering the total number of shares outstanding. Since the market capitalization remains the same, and there are fewer shares, the price of the stock goes higher. Hence, if you own 100 shares of a company prior to a 1:10 reverse split, you'd have 10 shares following the split.

Another fact to consider is that NeoStem was not forced to reverse its stock. We often see reverse splits so that companies can avoid delisting due to not meeting the pricing requirements of the exchange. However, NeoStem trades on the NYSE, which does not have a share price requirement, unlike the NASDAQ. Therefore, the purpose of this split is apparently to raise the stock price so that NeoStem will be more attractive to new investors, including institutional investors.

Why Does The Split Add Value?

You might wonder "why is a reverse split good for a stock?" Unfortunately, there is no fundamental reason, but is rather psychological. I think Amy Baldwin said it best: "It is a perception changer."

For example, NeoStem is a $110 million company, but traded at just $0.57 a share. As a result, there are a lot of retail investors, and hedge funds, that won't even look at the stock regardless of its data or its potential. Think about it, how many investors do you personally know that go searching for stocks under $1? Probably, not too many.

A couple weeks ago the Russell rebalanced its index funds, and with a market cap between $110 and $120 million, it is very possible that NeoStem could have been included. If so, it would have added millions to the company's market cap as all the funds that track Russell indexes would be forced to add NeoStem by default. Indirectly, such an inclusion can create a great deal of upside for a small-cap stock.

Instead, because it did not meet the stock price requirement, NeoStem stood no chance at being included. But now, with it trading over $1.00, it will qualify to be included in new funds, and will show on the radar of hedge funds who are unable to buy stocks that trade below $1 or $2. According to Reuters data, NeoStem has just 4% of its shares held by institutions. This is not because all institutions dislike the company, but rather not many can buy it.

According to NeoStem CEO Dr. Robin Smith, "We believe the resulting increase in share price will demonstrate the true value of NeoStem's common stock and broaden the appeal of our shares to investors, particularly institutional investors." Basically, Dr. Smith is realizing the same catalysts that I foresee. She knows that a $5.70 stock is much more attractive to institutional investors versus a $0.57 stock. Moreover, at $5.70 a share, NeoStem will trade at a price that exceeds the minimum price level for almost all funds and indexes. Most notably, these minimum prices are most commonly $1, $2, and $5 for the majority of institutional investors. Hence, the split should take care of NeoStem's low institutional ownership problem, and could lead to a favorable return for current investors.

Looking Ahead

The reverse stock split of NeoStem opens the company to a whole new group of investors, those who would've never given the stock a glance in the past. This is a company that has great connections to The Vatican, prestigious universities and Baxter (NYSE:BAX) (as noted by Aegis Capital). It has based the development of its newest clinical therapeutic VSELS off a technology that won Shinya Yamanaka the Nobel Prize in 2012, and has a Phase 2 product for the treatment of patients following an acute myocardial infarction that produced not one deterioration of heart muscle function at its threshold dose. Not to mention, it has a revenue producing manufacturing business that grew 99% last year, which works with the likes of Baxter and ImmunoCellular Therapeutics (NYSEMKT:IMUC).

Despite the diverse business structure and the noted catalysts from last year, NeoStem has traded flat over the last 12 months. For any other company with a Phase 2 product, that has peak sales potential of $1.3 billion, the announcement of no deteriorations in heart function would have doubled shares, but not NeoStem. With that said, one might think the risks outweigh the upside. However, the company has already raised money, and is well capitalized until data read out for its Phase 2 trial. If successful, the outlook for the company would change drastically due to the sales potential. But if unsuccessful, this is a company that still has a revenue-growing business that should add value over a course of many years.

My theory is that this reverse split will present new opportunities and will create greater shareholder value over the next year. The company has added three new clients to its manufacturing business, and will be presenting final Phase 2 data within the year. Moreover, VSELs have advanced into clinical trials, and have been very promising in early studies. With NeoStem being an undervalued company, I think the combination of events makes it worthy of watching in the immediate future.

Source: What Does This Reverse Split Mean For NeoStem Shareholders?