DryShips: The Party Continues

| About: DryShips Inc. (DRYS)

Summary

DRYS is an interesting name that has traded wildly.

The name has a history of reverse splits.

With a new split coming I walk through the impact on hypothetical investments.

DryShips Inc. (NASDAQ:DRYS) is a very interesting company. You may recall this fall when rampant speculation drove this long dollar stock up 20 fold. The name, for my followers who are unfamiliar with the company, owns drybulk carriers and shipping vessels, as well as supportive offshore infrastructure. It works frequently with clients in the mining, energy, and food companies, along with various other clientele.

Given the terrible performance the stock has generally had over the last few years, the recent spike in shares was cause for massive dilution as Seeking Alpha colleague Bill Maurer elegantly covered. What you may not know however, is this name also dilute its investors through value destruction? What do I mean? I am talking about reverse splits. It's done a few over the years, including last year. Just 5 months after the last reverse split, the name is at it again. Why?

Well, many management teams try to keep their shares above the $5 mark. This is for a whole host of reasons, but primarily this is done to attract institutional investment, and keep retail investors from shying away from the company's stock. Some creditors also won't lend to companies or won't give favorable debt financing to companies with dollar or penny share prices. One simply has to look at companies that have reverse split in the past to see that it often does not work out well, and in most cases shares continue falling post-split. But, another reverse split is coming.

The latest in the saga of DRYS reverse splits will be conducted at a ratio of one new share for every eight held. Now, this split of course was approved back in the fall, but the exact terms of the split were left to management to mull over to determine the exact ratio. A 1-for-8 was deemed appropriate. The reverse split will apply to shareholders of record as of the close of the markets on January 20, 2017 and will begin trading at the adjusted price Monday January 23, 2017. The ticker symbol for the fund will not change. The fund will be issued a new CUSIP number.

Now, I thought I would take the opportunity to discuss what happens with a reverse split. The reverse split will increase the price per share of the stock with a proportionate decrease in the number of shares outstanding. In a 1 for 8 reverse split, every eight pre-split shares held by a shareholder will result in the receipt of one post-split share, which will be priced eight times higher than the value pre-split share. (If you hold 400 shares of DRYS priced at $1.25 each, then after the reverse split you will hold 50 shares valued at $10.00 each.) Thus, the reverse split does not change the value of a shareholder's investment.

There are two more considerations to think about during this split. What happens with fractional shares, and what happens to owners of options contracts.

Fractional Shares From Reverse Splits

Now, I will say up front that the company will NOT be issuing fractional shares with this move. In the interest of this exercise, for those shareholders who hold quantities of shares that are not a whole number with an exact multiple of the reverse split ratio, the reverse split would result in the creation of a fractional share. This will affect any shareholder who does not hold a number of shares that is a multiple of eight. After the reverse split occurs fractional shares will be redeemed for cash and sent to your broker of record. The major issue associated with such a move is that it forces shareholders to realize either gains or losses, which could result in a taxable event for those shareholders, in addition to a having a potential loss on investment if prices are below where they were purchased. Yes, even if its pennies. With the way this stock has moved, a loss is quite possible. One way to mitigate this is to purchase more shares to round out your holdings to a multiple of eight, or to sell an appropriate number of shares to round out the holdings.

For Those Holding Options Contracts On

For those traders who may be holding options on DRYS, this split would affect your contract, albeit minimally. Once the reverse split is conducted, the contract undergoes an adjustment that is commonly known as "being made whole", which means the option contact is modified accordingly so that options holders are neither negatively nor positively affected by the split. While we know the reverse split will adjust the price of the underlying shares of the DRYS option, the option will be adjusted so that the changes in price due to the split do not affect the value of the option.

So if there is positive or negative effect on the option value, just how much will the option be worth post-split? You actually don't need to worry about such things, because the options clearing corporation automatically adjusts the price to maintain the option market. However, for those who want an estimate of what the DRYS option will be worth, the calculation is simple. Each option contract is usually in control of 100 shares of DRYS at some predetermined strike price. To find new the share coverage of the option after the split, all you do is simply take the split ratio and multiply by the old share coverage (normally 100 shares). To find the new strike price, take the old strike price and divide by the split ratio.

Let's look at an example of a call option contract for 100 shares of DRYS at a strike of $1.00. Since the split is 1 for 8 we divide $1.00 by 1/8, generating a new strike price of $8.00. The option will now cover 12.5 shares because we multiply 100 by 1/8, in theory. Thus, your new call option contract (which will expire on the same day as originally scheduled) will be good for a purchase 12.5 'new' shares of DRYS for $100.00. On your brokerage account, the contract may be adjusted to read "DRYS1" or similar and still state it is worth 100 shares at the original price, but for redemption purposes, the contract would be redeemed for 12.5 shares at the post-split price.

OF course, no one is really trading options on DRYS, and frankly with the low dollar share price, the stock itself trades like an option would. But for the purposes of the exercise I wanted to map this out.

Bottom Line

DRYS continues to sell-off slowly, with spikes in the stock here and there. You can make a fortune with the right timing, but so many have lost their shirts in this name. With the stock barely above $1 again, to 'save' the stock for reasons I mentioned in the opening, the company is conducting this reverse split. This reverse split doesn't change the value of any investments, but in my experience, is an invitation for a fresh bout of selling which continues to erode shareholder equity.

Disclaimer: This article is not a recommendation to buy or sell DRYS. It is for informational purposes only. The options contract analysis can be applied to all splits of other companies in the future by utilizing the outlined calculations.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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