In a move that will eliminate just over 70 percent of Lazare Kaplan’s current stockholders, the company plans to implement a “Reverse/Forward Split” for its stock on November 12, 2007, assuming shareholders approve the request.

 

Essentially, the company plans to eliminate stockholders with 100 or fewer shares of LKI stock. According to the company’s legal filings, the stockholders who are being cashed out own less than 1 percent of the total LKI shares outstanding.

 

When the dust settles from the stock split, four entities – the Tempelsman family, Fifth Avenue Group, Dimensional Fund Advisors, and other officers and directors (as a group) will own or control just over 80 percent of all LKI shares outstanding.

 

The Reverse/Forward Stock Split

Assuming stockholders approve, LKI will implement the reverse split which will give stockholders one share for each 101 shares they currently own. Stockholders with less than 101 shares will be cashed out; they will not be eligible to receive fractional shares, as sometimes happens in a reverse split. Currently, there are an estimated 1,786 LKI stockholders with 100 or fewer shares; there are currently about 2,500 stockholders of LKI shares.

 

Because this is a technical move to eliminate stockholders with 100 or fewer shares, as soon as those small stockholders are gone, the company will implement a forward split. All remaining shareholders – an estimated 700 stockholders – will receive 101 shares per one share of “reverse split” stock. The reverse split and forward split will occur about one minute apart. The company contemplates that the reverse split will occur at 6.00pm on November 12, and the forward split will occur at 6.01pm on the same day.

 

Company management has cited two key reasons for implementing the reverse/forward split which essentially eliminates holders of 100 or fewer shares:

 

• It is expensive for the company to send stockholder materials. Management estimates that the direct cost to maintain each stockholder is about $11.50 per year. In addition, there are indirect costs. Assuming all of the small stockholders are cashed out, LKI would save an estimated $25,000 per year in stockholder costs.

 

• It may be prohibitively expensive for stockholders with 100 or fewer shares to trade them in the market. The proposed reverse/forward split will be completed without brokerage fees.

 

After the reverse/forward split, there will be just over 700 stockholders who will own about 8.248 million shares post-split, down just barely from today’s 8.259 million shares, based on the company’s estimate of 10,700 shares which will be cashed out.

 

At most, about 178,000 shares could be cash out (1,786 shareholders times 100 shares each), but LKI management has said that each of the 1,786 shareholders own on average six shares each (we wonder if the company has done the math correctly, as illustrated in their proxy statement, but that’s a matter for the attorneys). Based on the company’s computations, 71 percent of the total stockholders will be eliminated; they hold less than 1 percent of LKI shares and voting power.

 

What Does A Reverse/Forward Split Do?      

If this reverse/forward split sounds complicated, you are correct. While we believe the company has done a good job of explaining the implications of the reverse/forward split in its proxy statement, it is a complex move because of the legalities involved.

 

Conceptually, though, it is simple: it eliminates small stockholders in a legal manner, and it saves the company money.

 

• This is a way that a company such as LKI can use to reduce its costs of being a public entity. Management says it will save about $25,000 per year by eliminating these small shareholders. While corporate revenues were $434.4 million for the most recent fiscal year, the company posted a loss of just under $3.0 million. So, if management can find costs to eliminate – however minor – it can help put the company back on the road to profitability.

 

• It is a way to “clean up” a company’s stockholder base. Most small stockholders never bother to return their voting materials. For most proxy questions, this is not an issue. However, if the company were to contemplate going private or selling itself, these small stockholders could make a difference in the vote, especially if the corporate charter is written in a way that their “uncast” votes are counted as “nay” votes.

 

A Legal Technique Under Delaware Law

Is this reverse/forward stock split legal? Absolutely. Because the company is incorporated in Delaware, the laws of that state permit the company to pay cash, rather than fractional shares, to owners of shares which are converted into less than one share in a reverse split. While we are unaware of any high profile reverse/forward splits recently on Wall Street, it is a technique that has been used in the past.

 

Will stockholders approve the reverse/forward stock split? The Tempelsman family controls nearly 60 percent of the votes. Typically, a two-thirds majority is required to implement this kind of split. We think that at least 6 percent of the remaining stockholders will agree with the company. In other words, it is a “done deal,” in our opinion. Said another way, if you own 100 or fewer shares of LKI, you will be cashed out in mid-November, no matter what your opinion is on the matter. The only way to remain an LKI stockholder is to purchase additional shares in the market to bring your total holdings to 101 shares or more.

 

After the reverse/forward split, the Tempelsman family will control (by vote) about 59 percent of the outstanding shares, followed by the Fifth Avenue Group with 26 percent of the shares (Matthew Fortgang and a trust for Susan Fortgang, formerly of Fabrikant, are the beneficial holders of these shares, with some voting restrictions which leaves them with voting power equivalent to 14 percent of the outstanding shares).

 

In addition, Dimensional Fund Advisors, a black box investor (a black box investor uses quantitative stats to make buy/sell decisions rather than fundamental research), owns just under 7 percent of the company shares. All directors and officers, except the Tempelsman family, hold about 2 percent of the company’s shares. Thus, just over 80 percent of the company’s shares and voting power are hold by these four groups.

 

Our best guess of what happens next? There is another chapter, and it could be titled, LKI Goes Private. It probably won’t happen near term. On the other hand, with weak results and a depressed stock price, it could be attractive for management to implement a buy-out. De Beers did just that under similar conditions, and in hindsight, it was an extremely smart move.