White Knights or Machiavellians? Understanding the motivation for reverse takeovers in Singapore and Thailand Pantisa Pavabutr1 Thammasat University This draft: October 2017 Abstract We analyze the characteristics, return, and financial performance of 47 RTO sample firms in Singapore and Thailand between 2007‐2015. Given the existing regulatory screens imposed by Singapore and Thai exchanges, we cannot find evidence that firms choosing to list via RTOs signals a separating equilibrium of low type firms seeking a listing short‐cut. We argue that RTOs should not be evaluated as a choice of listing per se, but as part of the parcel of long‐term corporate strategy. Analysis in this paper yields important in sights on reverse takeovers from both investor and regulator perspectives. JEL Classification: G14, G34. Keywords: Reverse takeovers, Back‐door listings, Emerging markets. 1. Introduction Equity markets have both an allocation and monitoring role. The challenge for regulators is striking a delicate balance between overseeing transparency and fair rules governing listings for efficient allocation of resources and investor protection without delineating potential firms from entering organized exchanges. The dual paths to listing can be direct through an initial public offering (IPO) or indirect through a reversed takeover (RTO). An IPO is traditionally seen as a young company with full listing qualification coming of age and offering shares to the public. A reversed takeover is the process whereby a private company acquires a controlling stake in a public company in order to obtain listing status. In doing so, RTOs allows private firms to list and seek out growth opportunities by merging with public firms and to seek listing without too much dilution and vulnerability to market conditions. However, anecdotal and some selected empirical evidence suggests a dark side to RTOs as they are often referred to as “back‐door listings” with transactions associated with opaque firms wanting to bypass stringent listing rules or a method in which is a holding company of the shell firm tries to get rid of non‐performing assets by passing it along to the next uninformed investor. Under this setting, there are two issues where reversed takeovers are subject to debate. First, should reverse takeovers be allowed or should regulations be tightened? The second issue, is why should firms choose RTOs instead of IPOs? The drawbacks of RTOs is that their speed and cost saving benefits are often overestimated in particular with on‐going trends towards more regulatory scrutiny 1 Associate Professor of Finance, Thammasat Business School, [email protected]. The author wishes to thank the National Research Council, and Thailand Research Fund for grant support. The author appreciates research assistance from Sippapon Ithiprachayaboon, Prasit Sutthikamolsakul, and Nina Taphunwong. Comments welcomed. 1 pertaining RTOs in equity markets around the world (Sjostrom, 2008; Vermeulen , 2014). Pavkov (2006) suggests that a complete analysis of benefits and costs of RTOs should include all stakeholders involved. Our study contributes to the almost non‐existing research on RTOs in ASEAN. Using 47 RTO sample firms in Singapore and Thailand between 2007‐2015, this paper addresses the above questions through discussion of existing listing regulations on RTOs and empirical analysis return and financial accounting performance. More specifically, it first briefly reviews existing regulations in Singapore and Thailand whether they are conducive for firms to list by RTOs rather than by IPOs. Second, it empirically analyzes the RTO samples by posing these questions 1), What are the characteristics of RTOs transactions? 2) What is the investors’ experience in RTO transactions over short and long‐term periods, and 3) What is the financial accounting performance of merged entity. The paper finds that given the existing regulatory screens imposed by Singapore and Thai exchanges, we cannot find evidence that firms choosing to list via RTOs signals a separating equilibrium of low type firms seeking a short‐cut to listing. This is because both exchanges require the newly merged entity to file a reapplication and comply with the same minimum standards as IPO listings. From company circulars and financial advisors report of sample firms, the number of days to completing the RTO transaction can be up to one year. In fact, about half of the RTO samples involve listing on the main boards of Singapore Stock Exchange (SGX) and Stock Exchange of Thailand (SET); the other half on the second boards of Catalist (CAT), and Market for Alternative Investment (MAI). If a RTO is a venue for easy listing, then surely more transactions would have occurred on secondary boards where listing requirement is more flexible, in particular on CAT. Second, after examining the characteristics of sample RTO deals, we find 32 firms or 68% of the sample firms are classified by the auditor as financially distressed, and approximately half of the transactions occur across firms with different industries. This implies that outsider firms intend to takeover a “shell” or non‐performing firm in an unrelated industry. Next, we examine the investor’s experience by measuring short‐term abnormal returns around RTO announcements and long‐term 12 months return post‐announcement. The cumulative abnormal return (CAR) of distressed firm RTOs during event window [‐10,10] around RTO announcement (MOU date), is 28.8% significantly higher than 8.4% of non‐distressed firms. Over a holding period of 12 months in which the buy‐and‐hold abnormal return (BHAR) is evaluated, much of the original short‐term gain reverted primarily because of continuing capital increases. Even so, the mean BHAR of RTO samples are higher than the mean BHAR of control firm sample. Looking at financial performance, distressed firms’ net profit margins and return on assets improved after RTO completion, but non‐distressed firm performance remains relatively superior to distressed ones. In sum, in our analysis of short‐term and long term return performance we do not find evidence that our sample RTOs transactions are causing market instability through fraud and pump‐and‐dump schemes. If the ease of listing is not a reason for choosing RTO, then why do firms engage in these transactions? From our analysis, we view that RTOs should not be perceived as a listing tool alone but part of the parcel of long‐term corporate strategies where (i) the private firm can become a public company without immediate large dilution in ownership and still have an option to raise more funds later (many RTO transactions have warrant issue plans contingent on successful restructuring plans post‐transaction); (ii) the private firm wishes to takeover a distressed or non‐distressed target public firm by obtaining a bargain price since the target is substantially smaller and trading at a value weighted average price (VWAP) in the bottom decile trading range of the exchanges; (iii) the public firm controlling shareholders wishes to exit and is offered an attractive price to the private firm. RTO 2 transactions do provide a more liquid trading environment which facilitates exit, and iv), the motivation could be unique to the firms themselves. 2 There are altogether five sections in this paper. Section 2 provides background discussions on RTOs including deal structure, regulations, and related literature. Section 3 describes the sample data and describes key features of RTO transactions. In section 4, both descriptive and empirical methods are used to analyze the motivation for RTOs. Finally, section 5 concludes and discuss policy implications for capital market development. 2. Background on RTOs 2.1 Deal structure In a typical RTO the private company acquires a controlling stake in a public company in order to obtain listing status by allowing the listed firm to acquire its assets or equity and in return receive issued shares of the listed company. Figure 1: Illustration of reverse takeover Before transaction Shareholders of Shareholders of listed firm private firm Cash transfer, private placement or share swap Listed firm Private firm Transfer assets After transaction Shareholders of Shareholders of private firm listed firm (with more than 50% control) Merged firm 2 We also expect that by acquiring a loss‐making public firm, the private firm gains from tax shield. However, we do not have unconsolidated financial statements of private firms to evaluate this conjecture. In Singapore’s case, some foreign outsider firms are already listed overseas, but explain that they prefer to list on the Singapore exchanges to increase their international profile in Asian markets. With RTOs they do not need to pay underwriting fees. Other outsider firms conduct RTOs as a short‐cut to international diversification (Perrenial China Retail Trust transaction with St. James Holding) or a short‐cut to business diversification (Singha Estate transaction with Rasa Property on SET). 3 Figure 1 illustrates the reverse takeover process. In exchange for assets transfer of private firm, the listed firm may choose from one or combination of payment in cash, new shares issue through private placement, borrow, or issue new shares to swap with private firm. In a RTO, the listed firm is often referred to as a shell firm if it has the following properties: (a) no or nominal operations; and (b) either: (1) no or nominal assets; (2) assets consisting solely of cash and cash equivalents; or (3) assets consisting of any