OLD POST – Original posted on May 18, 2011
Company A is listed. It has only 100 shares of R1 each, hence a share capital and equity of exactly R100. However unrealistic, it also has no other assets, liabilities or operating costs.
For all effective purposes, we would call Company A a “cash shell”, as its only real asset is its listing.
Company B is a private company with an operating business that generates, say, R100 of profit per year.
Company B is private and currently wanting to list on the stock market. Maybe it wants to raise capital really quickly and going through the formal listing processes would simply take too long? Perhaps it also feels that a formal new listing would be too expensive?
Whatever its motives, Company B wants to reverse list and selects Company A to be its vehicle onto the stock market.
Company A enters into an acquisition agreement with Company B whereby Company A buys the whole of Company B. Let us say that Company B’s fair value is at a Price Earnings of 10x net profits, thus with a R100 profits Company A’s acquisition price of Company B is at a fair value of R1,000.
Now–and this is the tricky part–Company A does not pay cash for Company B. Rather, Company A issues 1,000 new R1 shares in itself to Company B’s old shareholder to pay the R1,000 acquisition price.
That means that Company A now has a share capital of 1,100 R1 shares (R1,100). It also means that Company B’s old shareholder now controls 91% (= 1,000 / 1,100) of Company A’s share capital.
Hence, Company B’s old shareholder now controls Company A.
Notice how a change of control has occurred? Notice how Company A has now transformed from a cash shell into a holding company with an operating subsidiary, which is Company B?
In other words, Company B is now listed and investors can buy shares in Company A to participate in its profits.
Instead of becoming a separately listed company, Company B has listed through Company A’s listing and its shareholders still maintain control of the listed entity.
This is what a “reverse listing” is and, until recently, companies could do this effectively below the radar.
Recently, though, the JSE has amended the listing requirements and definitions to include reverse listings. This means that reverse listing need to go through basically the same listing processes and procedures as a new listing before reverse listing.
In this way the costs and risks of reverse listing have increased and it is more than likely that the number of reverse listing in the future will drop.