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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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