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ReversetakeoversisatopicthatisnowexaminableinP4.Thisarticleaimstoprovideanexplanationofreversetakeoversandtodiscussthepotentialbenefitsanddrawbacksassociatedwithreversetakeovers(RTO).

REVERSETAKEOVERS–ANEXPLANATION

AnRTOinvolvesasmallerquotedpanytakingoveralargerunquotedpanybyashare-for-shareexchange.Inordertoacquirethelargerunquotedpany,alargenumberofsharesinthequotedpanywillhavetobeissuedtotheshareholdersofthelargerunquotedpany.Hence,afterthetakeoverthecurrentshareholdersinthelargerunquotedpanywillholdthemajorityofthesharesinthequotedpanyandwillthereforehavecontrolofthequotedpany.

OnpletionofanRTO,itisusualforthequotedpanytobemanagedbytheseniormanagementteamfromthepreviouslyunquotedpanyandtotakethenameofthepreviouslyunquotedpany.

ThroughtheRTO,thepreviouslyunquotedpanyhaseffectivelyachievedalistingonthestockexchange.EddieStobbart,aroadhaulagepanybasedintheUK,achievedalistinginthiswayin2007bybiningwithWestbury,apropertyandlogisticspany.

ItisworthnotingthatintheUSA,theterm'reversemerger'isoftenusedasopposedtothetermreversetakeover.

Asever,therearemanyvariationsonthebasicidea.Forinstance,anRTOmayinvolveaquotedpany,whichisactivelytrading,orashellpany,whichisnotactivelytrading.

RTOshaveoftenbeendeemedtobethepoorman’sinitialpublicoffering(IPO)perhapsduetoUSstudiesshowingthatpaniesachievingalistingthroughareversemergergenerallyhavelowersurvivalratesandunderperformparedtopanieswhohaveachievedtheirlistingthroughatraditionalIPO.

However,studiesintheUKhaveshownthatthisisnotnecessarilythecase.Indeed,duringtheperiod1995to2012,RTOsseemtohavesurvivalratessimilartothoseforIPOs.ThebestresultsseemtoarisewithRTOs,whichinvolveaquotedpanythatisactivelytrading,asthetakeoveristhenabletobenefitfromsynergygains.Equally,smallRTOsseemtoperformbetterthanlargerones.

REVERSETAKEOVERS–THEPOTENTIALBENEFITS

Aspreviouslystated,anRTOiseffectivelyawaythatacurrentlyunquotedpanycanachievealisting.Hence,justaswithanIPO,thepanyobtainsthebenefitsofthepublictradingofitssecurities.Thesebenefitsinclude:

Easieraccesstocapitalmarkets

Asalistedpany,morefinanceislikelytobeavailableandthecostofthatfinanceislikelytobelowerthanifthepanywasstillunquoted.

Higherpanyvaluation

Asthesharesinthepanywillbelisted,potentialinvestorswilldeemthesharestobelessriskyasthepanywillhavetoabidebytherelevantrulesandregulations.Additionally,theywillknowthatthesharesareliquidandthatwhenevertheywishtoselltherewillbeawillingbuyer.Asaresultofthis,investorsarelikelytoattributeahighervaluetotheshares.

Enhancedabilitytocarryoutfurthertakeovers

Oncethesharesinapanyarelisted,thepanyisabletoacquireotherpaniesthroughfurthershare-for-shareexchanges.

Enhancedabilitytousesharebasedincentiveplans

Oncethesharesofapanyarelisted,sharebasedincentiveplanscanbeusedasakeytooltoattractandretaingoodqualityemployees.

Inadditiontotheabove,anRTOhasanumberofotherpotentialbenefitswhenparedtoanormalIPO.Theseincludethefollowing:

Speed

AnIPOcanoftentakebetweenoneandtwoyearstopletewhereasanRTOcanbepletedinaslittleas30days.Furthermore,theworkrequiredtopleteanIPOcanmeanthatthemanagersofapanyhavelesstimetorunthepany,whichmayprovedetrimentaltothegrowthprospectsofthepany.ThevariabilityofmarketconditionscanalsomakethespeedofanRTOattractive,asinthetimetakentoprepareforanIPO,themarketmaydeterioratesuchthattheIPOisnotfinallyworthpleting.Furthermore,particularcircumstancesinamarketmaymakeRTOsattractive.Forinstance,inChinatheIPOprocessisnotoriouslyslowandthereisusuallyasignificantqueueofpanieswaitingtocarryoutanIPO.AnRTOallowsapanytojumpthisqueue.

Cost

JustasanIPOisatime-consumingprocess,itisalsoanexpensiveoneduetothevolumeofworkrequiredbyinvestmentbanks,sponsors,accountantsandotheradvisers.AnRTOwillusually,butnotalways,costless.

Availability

InamarketdownturnitisnoteasytoconvinceinvestorstosupportanIPO,whereasthisdoesnotseemtobethecasewithRTOs.StudieshaveshownthatthevolumeofRTOtransactionsisfarmoreresilienttomarketdownturns.Duringthemarketcorrectionthatfollowedtheburstingofthedobubble,thenumberofRTOsactuallyincreasedwhilethenumberofIPOsfellverysignificantly.

Similarly,thefallinthenumberofRTOswaslessthanthefallinthenumberofIPOsfollowingthemorerecentfinancialcrisis.Thisisprobablybecause,withanRTO,thedealisfundamentallybetweentheshareholdersofthequotedandunquotedpaniesinvolvedand,hence,marketsentimenthasmuchlessimport.

Furthermore,whileanRTOisoftenapaniedbyaconcurrentsecondaryofferingtoraisenewfinance,theamountofnewfinancebeingraisedinboth$and%termsisusuallylessthanthatwhichisraisedduringanIPO.Hence,eveninadownturn,investorsareoftenmorewillingtosupportanRTOratherthananIPO.

Existinganalystcoverage

AlistedpanysubjecttoanRTOislikelytohaveexistinganalystcoverageand,aftertheRTO,thisanalystcoverageusuallycontinues.However,paniesthatuseanIPOmaystruggletogetsignificantanalystcoverageespeciallyiftheyaresmaller.Withoutreasonableanalystcoverage,potentialinvestorsmaynothavemuchawarenessofthepanyand,hence,areunlikelytowanttoinvestinthepany.

REVERSETAKEOVERS–THEPOTENTIALDRAWBACKS

RTOsdo,however,haveanumberofpotentialdrawbackswhenparedtoanIPOandanypanyconsideringanRTOshouldbeawareofthese.

Lackofexpertise

ApanyachievingalistingthroughanRTOmayfindthatitdoesnothavetheexpertisetounderstandanddealwithalltheregulationsandproceduresthatlistedpaniesmustplywith.ThelongprocessoflistingthroughanIPOcanbeviewedasavaluabletrainingperiodandanypanythathasbeenthroughtheprocessisinabetterpositiontodealwiththerequirementsoftheexchangethanapanycatapultedontothemarketthroughanRTO.Hence,anypanyconsideringanRTOmustconsidertheneedtohireand/orretainstafffromtheexistinglistedpanywhoareabletokeepthepanypliantwithalltherelevantregulations.

Reputation

Aspreviouslydiscussed,anRTOhasoftenbeenviewedasapoorman’sIPO.Hence,paniesthatachievetheirlistinginthiswaymaybeviewedlessfavourablybyinvestorsthanpaniesthathavepletedanIPO.Tosomeextent,thereasonsforthislieintherecentpast.

In2011and2012,therewereanumberofaccountingscandalsinvolvingChinesefirmsthatgainedaccesstotheUSmarketsthroughRTOs.Indeed,over100paniesweresuspendedordelistedasaresult.ApublicbulletinissuedbytheUSSecuritiesandExchangeCommissioninJune2011warnedinvestorsbystatingthat‘manypanieseitherfailorstruggletoremainviablefollowingareversemerger’andthattherehavebeen‘instancesoffraudandotherabusesinvolvingreversemergerpanies’.

Sincethattime,theregulationsandstandardsthatapplytoreversemergers/RTOsontheUSstockexchangesandotherexchangesaroundthewordhavebeentightenedupinordertopreventsimilarproblemsarisinginthefuture.

Risk

AsaresultofthelowerlevelofscrutinythatisappliedtoanRTOparedtoanIPO,investorsmustbeawareofthehigherlevelofriskthatisattachedtopaniesachievingalistinginthisway.Inparticular,theunquotedpanycarryingoutanRTOmustensurethatthereisathoroughinvestigationofthelistedpanywhichtheyaretakingoversothatallpotentialproblemsandliabilitiesarerevealed.

Regulation

AlthoughRTOscangenerallybepletedmorequicklythananIPOasthereislessregulationandscrutinyinvolved,itmustberecognisedthattherearestillasignificantamountofregulatoryhurdlestoovee.ItshouldbeunderstoodthatRTOsare,tosomeextent,binationsofacquisitionsandIPOsand,assuch,arepotentiallyplexanddifficultdealstomanage.Bywayofexample,tworegulatoryissuesthatmayarisearenowdiscussed:

Suspension

TheFinancialConductAuthority’s(FCA)standardviewisthatwhenanRTOisannouncedorleaked,therewillgenerallybeinsufficientinformationpubliclyavailableontheproposedtransaction.Inparticular,informationontheunquotedpanycontemplatingthetakeovercouldwellbelimitedparedtotheinformationthatisavailableonlistedpanies.Asaresultofthis,thelistedpanywillnotbeabletoaccuratelyassessitsfinancialpositionandinformthemarket.Hence,theFCAwilloftenconsiderthatasuspensionoftradinginthesharesisappropriate.Thisstandardviewcanberebutted,butthereissignificantworkrequiredtoachievethis.However,thisworkisessentialasthelistedpanywillnotwanttocontemplateascenariowhereitslistingissuspendedandisquitelikelytowalkawayfromtheproposedtransactionwerethistooccur.

Mandatoryoffer

If,individuallyorwiththeircloselyconnectedpersonsorfriends,anyshareholderintheunquotedpanycarryingoutanRTOwillonpletionofthetransactionholdsharesthatcarry30%ormoreofthevotingrightsofthelistedpany,thenthatshareholderwillberequiredtomakeageneralcashofferfortheremainingsharesinthelistedpanyunderthemandatorybidrule.ThiswouldobviouslyunderminethereasonfordoingtheRTOinthefirstplace.Whilethetakeoverpanelwillusuallyconsenttoawaiverofthisrequirementaslongascertainconditionsaresatisfied,itisanotherregulatoryobstaclewhichmustbenavigatedaroundcarefully.

Sharepricedecrease

ManylistedpanieswhichcouldmakepotentialRTOtargetsareinthatpositionbecauseofpastproblems.Hence,theymayhaveshareholderswhoarekeentoexitfromthepanyassoonasasuitableopportunityarisesand,hence,theymay‘dump’theirsharesshortlyaftertheRTOhaspleted.Tosafeguardagainsttheriskofa‘dump’occurring,theshareholdersmayneedtoguaranteethattheywillnotselltheirsharesuntilacertainperiodoftimehaselapsedsincethedealispleted.Thisiscalledalock-upand/oralock-upperiod.

Cost

WhileareversetakeoverisusuallycheaperthananIPO,therearestillsignificantdirectandindirectcostsinvolvedand,hence,thetotalcostcaneasilybefarmorethanwasoriginallyanticipated.Anumberofthesecostsarenowconsidered:

Regulatorycosts

Asmentionedpreviously,anRTOisaplextransactionandtoensurethattheregulatoryhurdlesaresuccessfullyoveewillincursignificantcost.

Acquisitioncost

AsaresultofanRTObeingseenasaneasierandquickeroptionthananIPO,especiallyintheChinesemarket,thevalueofpotentiallistedpanytargetsareoftenatasignificantpremiumtotheirtruevalue.Furthermore,thepressuretofindatargethasresultedinsomeunusualbinationssuchasamobileputergamedevelopergettinglistedthroughtheacquisitionofashoepany!Itishardtoimaginetherewereanysynergygainsavailablehereand,indeed,resolvingculturalandotherissuesthatmaywellhavearisenwouldhavefurtheraddedtotheindirectcostofachievingthelisting.

Investorrelations

AlthoughanRTOmaybenefitfromexistinganalystcoverage,RTOtransactionsonlyreallyintroduceliquiditytoapreviouslyprivatepanyifthereisrealinvestorinterestinthepany.Inmanycases,inordertogeneratethisinterest,aprehensiveinvestorrelationsandinvestormarketingprogrammewillberequired.ThisisanotherpotentialindirectcostofanRTO.

CONCLUSION

Aswithanythingthatseemstoogoodtobetrue,itmustberecognisedthatanRTOisnotwithoutsignificantplicationandcost.Justasthereisnosuchthingasafreelunch,thereisalsonoeasywaytoachievealisting.

WilliamParrott,freelancetutorandseniorFMtutor,MATUganda

References:

BPPACCAApprovedStudyText

Reversetakeovers:Nolongerthepoorman’sIPO,M&AResearchCentreatCassBusinessSchool

ReverseTakeovers,Steppingthroughthelookingglass,KarenDavies,DominicRossandJamesFletcherofAshurstLLP

LeapfroggingtheIPOgridlock:Chinesepaniesgetatasteforreversetakeovers,ElzioBarreto

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