IPOs cold wind opens the back door

More reverse takeovers expected in 2013 as capital-seeking companies find new avenues to list.

By Tony Featherstone

The old saying, “as one door shuts, another opens”, aptly describes the sharemarket for capital-seeking companies. As the market’s front door, initial public offerings (IPOs), becomes even harder to budge in a bear market, there has been a resurgence in so-called backdoor listings.

Sixteen companies have successfully recomplied with ASX Listing Rules so far this year, Australian Securities Exchange data shows. More are on the way as a troubled IPO market, and the rising number of dormant shell companies, encourages backdoor listings or reverse takeovers.

The trend is well established, with 27 backdoor listings in 2011, according to ASX data. Pioneering research by Dr Peter Lam of UTS Business School shows that figure compared to a peak of 32 backdoor listings in 2000; they were popular that year as dot.com companies did reverse takeovers of failed explorers. However, some care is needed with comparisons due to different interpretations of back-door listings around ownership and control.

Prominent backdoor listings in 2011 included Yellow Brick Road Holdings, run by executive chairman Mark Bouris, which backdoor listed last year through the failed migration business, Interstaff Recruitment. Coal explorer ZYL was another prominent 2011 backdoor listing, using the shell of the Perth technology company ZYL and raising $30 million.

Anecdotally, there is talk of many more backdoor listings in the next 12 months as the next wave of corporate carcasses provides fodder for companies seeking to raise capital and list on ASX without the seemingly higher cost and time taken in an uncertain IPO market.

The backdoor listings market often moves in long cycles: failed exploration companies in 2000 were fodder for dot.com companies, which then became shell companies for emerging life science and mining companies in the middle of the decade. A slowdown in the mining investment boom could spark the next wave of backdoor listings as more micro-cap explorers go bust.

The accompanying table shows companies that have recomplied with ASX Listing Rules and been readmitted to ASX. Although a backdoor listing effectively creates a new entity, ASX requires companies to seek shareholder approval for backdoor listings and recomply with exchange requirements. The rules are broadly the same for IPOs and backdoor listings.

Unlike IPOs, backdoor listings usually have little fanfare and often slip below the radar of the media and retail and professional investors. There is no central information source that promotes upcoming backdoor listings, or tracks their aggregate performance.

This rising popularity of backdoor listings makes sense. For one thing, the IPO market is on life support as global sharemarket volatility and retail investor risk-aversion decimates demand and post-listing support for new offers. Many IPOs have been extended several times this year due to low interest and at least a dozen have been withdrawn.

Only 30 or resource-related companies, mostly micro-cap explorers, have successfully floated so far in 2012. To put that in perspective, 89 resource-related IPOs in 2011 raised $755 million. Even at the depth of the GFC in 2008, about $2 billion was raised from 72 floats (including non-resource ones) when market uncertainty was greater than today.

The median capital raised so far from IPOs this year is just $4 million, which is barely enough to fund a decent two-year exploration program after offer costs. The median value of each company listed was $7.1 million. The median share price loss (compared with the issue price) this year for resource-related IPOs is 10 per cent and a third of all new floats have sunk by more than 30 per cent.

Bigger problems loom. Hundreds of micro-cap IPOs in the past five years have been forced to raise far less capital than they had hoped and struggled to achieve their minimum subscription. Many that listed in the past 18 months will soon need another capital raising to survive. For some, a battered share price and the prospect of more dilution from an equity capital raising will be their death knell.

Waning interest in speculative resource stocks, and ongoing sharemarket weakness, will compound the capital-raising problems of recently listed micro-cap explorers. Many will be unable to raise fresh capital, run out of cash, and become an attractive shell company for the next backdoor listing.

More ASX-listed shell companies for sale should mean lower prices for those seeking backdoor listings. There has been some talk that prices to acquire shell companies are falling, although evidence is anecdotal. More telling is the rising cost of equity capital for small IPOs, with a fifth of capital raised often chewed up in offer costs, as advisers require higher fees in a volatile market. Even some nano-cap IPOs this year have had all or part of their offer underwritten for a hefty fee.

Greater choice of ASX-listed shell companies also provides important options for vendors. Good shell companies can be hard to find. The best usually have some cash, a small shareholder base, simple operations and less baggage in the form of outstanding debts or litigation. The shells of failed exploration companies can appeal to other miners seeking backdoor listings, because they often have some cash on the balance sheet, one or two key assets, and are a good fit with the new owner.

Backdoor listings are often favoured over IPOs because they are seemingly faster and less complex transactions. Yet the reality is that backdoor listings require considerable due diligence and often take as long, or longer, than IPOs as the acquirer seeks shareholder approval and exchange recompliance.

IPOs in this market are taking much longer, as many smaller ones are forced to extend their offer several times to secure their minimum subscription or attract a sufficient spread of shareholders to comply with ASX Listing Rules. IPOs that open and close within a week are rare; for the majority it is a long, hard slog selling the offer to reluctant investors. Some backdoor listings seem easier by comparison.

Another problem with backdoor listings relative to IPOs – less publicity about the offer and support from broking firms – has also diminished. The IPO market has had a sharply lower profile in the media and investment community in recent years because of an absence of investment-grade offers. Most IPOs in recent years have been too small for the majority of retail and professional investors.

Aftermarket support is another consideration.  One IPO after another in recent years has struggled for post-listing support from investors, which is shown in the low percentage of IPOs that have finished their first year as a listed company ahead of their issue price. For all their challenges, backdoor listings at least promise more aftermarket support because of their established shareholder base. However, fewer escrow provisions in backdoor listings compared to IPOs (which have a higher proportion of restricted shares that cannot be sold) can lead to more selling upon readmission.

The big problem with backdoor listings is their poor aggregate long-term performance. Dr Lam’s research found backdoor listings collectively underperformed the sharemarket and comparable IPOs over a long period. His PhD  thesis, submitted in 2010, analysed 200 backdoor listings on ASX between 1999 and 2007, and provided rare insight.

Dr Lam found that backdoor listings, over three years from the date of their official reinstatement to ASX, underperformed the S&P/ASX 200 index by 62 per cent on average, and underperformed IPOs in similar industries by 37 per cent. Clearly, the odds are stacked against successful backdoor listings, although problems in the IPO market might make them a more attractive investment in coming years.

–       Tony Featherstone is a former managing editor of BRW and Shares magazines, and writes a weekly column on IPOs for the Australian Financial Review. All data and analysis at October 7, 2012. 

ASX Listed Entity’s – Recompliance with Chapters 1 and 2 of Listing Rules

Source: ASX

* some companies may have changed their name since re-admission.