Capital Markets

Why Shareholders Opposed DrKoop’s Reverse Split Plan

Some shareholders "Prefer" a delisting.
Jennifer CaplanJanuary 23, 2001

It seemed like a no-brainer at the time.

Desperately trying to get its stock above a buck to avoid being delisted from the Nasdaq, DrKoop.com Inc. proposed a reverse split. In other words, it wanted to exchange its current shares for new, albeit fewer shares.

Surprise!

Last week, the online healthcare site dropped plans to hold a shareholders vote on the matter when several of the company’s significant investors said they opposed the reverse stock split.

Drkoop had hoped to include the reverse split in its plan to remain on the Nasdaq, which it is expected to submit when it pleads its case at a hearing before the exchange on or before February 22, 2001.

But, why would Drkoop’s shareholders oppose a tactic that could help prevent the stock from being delisted? Were they short sellers?

Nah.

It seems most of the opposition came from the preferred shareholders who had earlier “saved” the company from bankruptcy and whose interests are at odds with the common shareholders.

Back in August 2000, DrKoop.com issued $27 million in preferred stock and warrants in a private placement with a group of investors, including Prime Ventures, JF Shea Ventures, Cramer-Rosenthal-McGlynn and RMC Capital. The initial price of the preferreds was $10 per share.

The preferred shares are convertible into drkoop.com common stock based on a price of 35 cents a share. Under the agreement, if the common stock falls below 35 cents, the conversion price is adjusted accordingly. At the time of the transaction, drkoop.com’s stock traded at $1.34. Altogether, the group received a total of 78.6 million shares at a 67 percent discount.

Nice deal, huh?

If DrKoop were acquired or if the company were to liquidate its assets, the preferred shareholders would have a liquidation preference of $15 per share, plus accrued and unpaid dividends.

That certainly explains why they opposed the reverse split.

“My guess is that these are the shareholders that said no to the reverse stock split,” says Rob Plaza, an analyst with mutual fund and stock rating firm Morningstar. “They have no incentive to care about the common equity shareholders. If anything, a DrKoop bankruptcy brings out a buyer for the company’s assets and Web Site, and those preferred shareholders get some of their money back.”

In other words, if DrKoop winds up filing for bankruptcy, it would sell off its assets and use its cash to pay its bills, Plaza says. Whatever money is left goes first to the preferred shareholders.

By agreeing to a reverse split, the preferred shareholders would simply be agreeing to prolonging the agony for Drkoop. The stock would probably limp along.

“Reverse stock splits generally do not work,” Plaza adds. “A company is still junk after it implements a reverse split, and its shares fall back to below a $1 anyway–with a lower number of outstanding shares.”

Besides, the folks at Nasdaq can see right through this type of last-ditch move, and frequently delist the company anyway, Plaza adds.

Nice try, but DrKoop’s chances of survival are looking pretty slim.