IPOs v. backdoor listings: rules and risks
Understand the process of reverse takeovers and their benefits and risks.
Federal Treasurer Joe Hockey is not the only one lamenting the long lost mining boom. With the iron ore price down by more than 75 per cent over the past four years, a long list of ASX-listed junior miners have given up any hope of turning a profit.
Many have effectively become “shell” companies: companies in name but lacking a viable business model. Many of them, particularly those with some cash left in the bank, are receiving new attention from a different group of investors: the owners of viable privately owned businesses looking to list on ASX.
This corporate marriage can result in a win-win situation. The shell company receives a new lease of life and the non-listed company gains its listed status. The two companies do not have to operate in the same business sector. Right now the toads are mainly junior miners, with fledgling tech companies delivering the corporate kisses.
It is referred to as a reverse takeover or backdoor listing and provides an alternative method of listing to the more conventional initial public offering (IPO).
This article explores the process of reverse takeovers and their benefits and risks.
How the deal is sealed
Before the two companies can officially tie the knot there are certain steps that need to be taken.
The ASX Listing Rules require the companies to seek shareholder approval and ensure ASX admission requirements are met. These requirements are broadly the same as for an IPO.
The already listed shell company can then acquire the shares or assets of the unlisted company. In exchange, the owners of the unlisted company receive shares and/or cash. If cash forms part of the deal, it can be delivered either through an associated capital raising or from the shell company’s bank account if any cash remains. The deal typically changes the company’s ownership and operations, and leads to new management and directors.
The broad benefits delivered are often overstated and in most cases there are few if any advantages over an IPO.
Two commonly stated benefits are the speed and ease of backdoor listings compared to IPOs. However, research undertaken by Dr Peter Lam, of UTS Business School, has found that the average backdoor listing takes longer to complete than a comparable IPO. In addition, brokers commonly state that a backdoor listing can cost the same or more to execute.
It seems that the decision between undertaking a backdoor listing or an IPO is strongly influenced both by the prevailing stockmarket conditions and the availability of suitable shells. When the market is flat or underperforming, investor appetite for new floats tends to be low. Under these conditions, small IPOs are difficult to get away and backdoor listings come into vogue.
In 2014 there were 30 backdoor listings on ASX, just short of the record number, 32, in 2000. This compares with 58 companies choosing last year to list on ASX via a traditional IPO.
Below is a list of the considerations of a backdoor listings:
The ASX Listing Rules require that a listed company’s share register has a minimum number of investors holding at least $2,000 worth of shares. The required minimum varies between 300 and 400 shareholders, with the actual number dependent upon the percentage of the total issued capital held by related parties. This requirement can be difficult to meet for small companies that are seeking listing.
A backdoor listing may assist in achieving the required shareholder spread to the extent there are existing security holders holding at least $2,000 worth of securities.
2. Access to cash
The shell might already have cash that the new management can put to work. This can reduce, or sometimes even dispense with, the need to raise new equity capital.
3. Scrip-for-scrip rollover relief
The Australian Taxation Office allows capital gains tax rollover relief on the disposal of shares if at least 80 per cent of the consideration paid for the shares in the unlisted business is paid using shares in the ASX-listed company. Capital gains tax liability is then deferred until the ASX-listed shares are ultimately disposed of.
4. Simpler than an IPO?
As mentioned, backdoor listings are not necessarily easier to undertake than IPOs, but sometimes they can be. For example, when both companies operate in a similar line of business and are of a similar size, a prospectus is not required. Conversely a backdoor listing can add complexity in some areas. For example, due diligence needs to be done on two companies (shell and target company) rather than just one as per an IPO.
5. Cheaper than an IPO?
Typically the costs are similar for a backdoor listing and an IPO. A major cost associated with both is the production of a prospectus/information memorandum, so unless the need for the prospectus can be dispensed with (when undertaking a backdoor listing) there is often little to choose between them.
Capital raisings and capital reconstructions associated with backdoor listings can dilute existing shareholders. A potential offset for these shareholders is if the share price lifts on the announcement of the plan.
UTS Business School’s Peter Lam looked at 200 backdoor listings undertaken on the ASX between 1999 and 2007. He found that over three years from their reinstatement to the ASX, backdoor listings underperformed the S&P/ASX 200 Index by 62 per cent on average and IPOs in similar industries by 37 per cent.
(Editor’s note: While this research is a little dated, it is an interesting consideration for investors)
Lam also found that the share price of the shell company spiked as the market speculated on a takeover, or as news was announced. Which means that buying into the shell company before its takeover was a better strategy than buying it after the listing.
Of course, this strategy is difficult for the average investor to undertake because there is usually little fanfare associated with backdoor listings. They are not promoted in the same way as IPOs because there is not the need to establish a broad base of new shareholders.
Lam’s findings indicated that existing shareholders typically gained more from backdoor listings than those who bought in after the company was reinstated to ASX.
And while this might sound like good news for existing shareholders remember that for many investors the price spike provides only partial compensation for a long-suffering share price.
Lam’s research identified some common characteristics in successful backdoor listings, with larger ones tending to perform better than smaller ones and those accompanied by capital raisings also doing better.
About the author
Michael Kemp is chief analyst at The Barefoot Blueprint.
Michael Kemp is chief analyst at The Barefoot Blueprint.
You can get an in depth knowledge of the ASX Listing Rules from the Rules, guidance notes and waivers section of the site.