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The Listing Rules’ requirements for reverse takeovers of Hong Kong listed companies

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The Listing Rules’ requirements for reverse takeovers of Hong Kong listed companies

Annex A – Summary of Listing Criteria for New Applicants

MAIN BOARD GEM
Financial
Requirements
Applicants must meet one of 3 financial tests A GEM applicant must have: Positive cashflow from operating activities in the ordinary and usual course of business of HK$20 million in aggregate for the latest 2 financial years
1. Profit Test 2. Market Cap/ Revenue Test 3. Market Cap/ Revenue Cash flow Test
Profit At least HK$50 million in the last 3 financial years (with profits of at least HK$20 million in the most recent year, and aggregate profits of at least HK$30 million recorded in the 2 years before that)
Market Cap At least HK$200 million At least HK$4 billion at the time of listing At least HK$2 billion at the time of listing Market cap of HK$100 million at the time of listing
Revenue At least HK$500 million for the most recent audited financial year At least HK$500 million for the most recent audited financial year
Cashflow Positive cashflow from operating activities of at least HK$100 million in aggregate for the 3 preceding financial years
Operating History and Management Main Board applicants must have:

    Ÿ

  • 3 years’ operating history;
  • Management continuity for at least the 3 preceding financial years; and
  • Ownership continuity and control for at least the most recent audited financial year.
GEM applicants must have:

    Ÿ

  • A trading record period of at least 2 full financial years;
  • Management continuity for at least the 2 preceding financial years; and
  • Continuity of ownership and control throughout the full financial year before listing.

Public Float

At least 25% of the issuer’s total issued share capital (subject to a minimum of HK$50 million for Main Board applicants and HK$30 million for GEM applicants) must be held by the public at all times.

For issuers with an expected market capitalisation at listing of at least HK$10 billion, the Exchange may accept a public float of between 15% and 25%.

Spread of Shareholders

The shares in the hands of the public must be held by at least 300 persons.

No more than 50% of the publicly held shares at the time of listing can be beneficially owned by the 3 largest public shareholders.

The shares in the hands of the public must be held among at least 100 persons.

No more than 50% of the publicly held shares at the time of listing can be beneficially owned by the 3 largest public shareholders.

Annex B – Listing Eligibility Requirements for Mineral and Petroleum Companies

  1. Right to explore for and/or extract Natural Resources (MB Rule 18.03(1)/GEM Rule 18A.03(1))

    New applicant Mineral Companies must be able to demonstrate that they have the right to participate actively in the exploration for and/or extraction of resources, either by having control over a majority (by value) of the assets in which they have invested or through other rights, which give them significant influence in decisions concerning the exploration for and/or extraction of those resources (MB Rule 18.03(1) (GEM Rule 18A.03(1)).

    The Exchange recognises that in practice, companies often engage in mineral extraction or exploration activity under joint venture agreements, product sharing contracts or specific government mandates. Therefore, the Exchange will consider, on a case-by-case basis, whether or not to allow an applicant to rely on adequate agreements where a third party possesses relevant rights, in order to satisfy this eligibility requirement.

  2. Ineligibility of Early Stage Exploration Companies

    New applicant Mineral Companies must have at least a portfolio of Indicated Resources (in the case of minerals) or Contingent Resources (in the case of petroleum) that are identifiable under one of the accepted reporting standards and substantiated in the report of an independent expert (MB Rule 18.03(2)/GEM Rule 18A.03(2)). The portfolio must also be of sufficient substance to justify a listing. These requirements therefore render early stage exploration companies ineligible for listing.

  3. Working Capital Requirement

    New applicant Mineral Companies must demonstrate that they have sufficient working capital for 125% of their budgeted needs for the next twelve months (MB Rule 18.03(4)/GEM Rule 18A.03 (4)). The working capital requirements must include, as a minimum, general and administrative costs, property holding costs and the cost of proposed exploration and development. Applicants that have commenced production must also provide an estimate of its cash operating costs.

  4. Waiver of Main Board Financial Tests/GEM Trading Record Requirement

    Main Board Rule 18.04 provides that if a new applicant Mineral Company cannot meet the financial track record requirements under Listing Rule 8.05, those requirements may be waived if the board and senior management, taken together, have a minimum of five years’ experience relevant to the mining and/or exploration activity that the applicant is pursuing.

    Under GEM Rule 18A.04, the Exchange may accept a trading record period of less than the two financial years specified in Rule 11.12A (and an accountants’ report covering a shorter period than that specified in rule 11.10) for a new applicant Mineral Company, provided that its directors and senior managers, taken together, have at least five years’ relevant industry experience. However, where the Exchange accepts a trading record of less than two financial years, a new applicant must still meet the cash flow requirement of HK$20 million for that shorter trading record period, in accordance with Rule 11.14.

ANNEX C – Summary of Listing Decisions involving VSAs falling outside the bright line tests

Listing Decision LD 95-1: the Approach where an extreme case does not attempt to circumvent the requirements for new listings applicants

In this Listing Decision, released in July 2010, the Exchange considered whether a company, whose main business was in security investments and manufacturing and trading battery products (“Company A”), would:

  1. become a cash company due to its proposed placing of convertible notes; and
  2. have its proposed acquisition of an insurance company (“the Target”) treated as a reverse takeover by the Exchange.

Company A proposed to raise funds to be used as working capital and for potential investment prospects by placing new shares to independent placees (the “First Placing”). This placing would result in Company A’s assets being comprised almost entirely of cash, making it a cash company under Main Board Rule 14.82. A listed issuer is treated as a cash company when, for any reason, its assets consist entirely or largely of cash or short dated securities. This leads to the company not being regarded as fit for listing and trading in its securities being suspended.

Soon after the announcement of the First Placing, Company A made an agreement to acquire the Target from an independent vendor in cash (the “Acquisition”), a transaction amounting to a very substantial acquisition. The Target was a considerably larger entity than Company A, which created an issue as to whether the Acquisition constituted a reverse takeover under Rule 14.06 (6).

In order to avoid being treated as a cash company and having trading in its securities suspended, Company A cancelled the First Placing, replacing it with a scheme involving the issuing of convertible notes to raise funds (the “Second Placing”), which would be redeemed within two weeks if the Acquisition did not go ahead.

Company A argued that Rule 14.06 (6) did not apply to the Acquisition as it would not cause a change in control to occur at the company, and also that the vendor had no intention of circumventing the IPO requirements. Rather the transaction constituted a forced sale by the vendor of its major assets with no prerequisite in relation to the listing status of the purchaser.

The Exchange on whether Company A was a cash company

Despite the revised technique of fund raising adopted by Company A, the Exchange determined that its assets would still largely consist of cash immediately after the Second Placing transaction. This would result in trading in its securities being suspended under Rule 14.83 and in order to avoid this, Company A restructured the Second Placing to prevent itself from becoming a cash company at any time, by making it subject to the conclusion of the Acquisition.

The Exchange on whether the Acquisition should be regarded as a reverse takeover

It was noted that the two tests detailed in Rule 14.06(6) are not exhaustive, and transactions effectively amounting to backdoor listings can be treated as reverse takeovers, although in practice this only occurs in extreme cases. The Exchange considered the Acquisition to be an extreme case, primarily on the grounds that it was very significant for Company A and the target operated in a completely different business. The Acquisition would have the effect of changing Company A’s business and was an attempt to achieve a listing of the Target’s business.

However the Exchange found that the Acquisition was not an attempt to circumvent the requirements for new listing applicants detailed in Rule 8.05(1)(a). Key factors in this finding were that the Target only failed to comply with the profit requirements under that section due to the effect of the global economic downturn, as opposed to a substantial decline in its ability to generate revenue, and the Target’s ability to meet the capitalisation/revenue test under Rule 8.05(3).

The Exchange decided that it would not treat the Acquisition as an RTO, and that the policy aims of the RTO Rules would be satisfied, once the following conditions were adhered to:

  1. Company A would publish a circular with a level of disclosure comparable to an IPO prospectus;
  2. The Circular would explain that the Target’s loss in the most recent year was transitory in nature and not due to serious deterioration of its operational capabilities; and
  3. Company A would appoint an adviser to perform due diligence on the Target and undertake duties and obligations commensurate with those of a sponsor for a new listing application under the Rules.

Listing Decision LD 95-2

In this Listing Decision, released in July 2010, the Exchange assessed whether an acquisition by a Main Board issuer (“Company A”) constituted a reverse takeover under Rule 14.06(6), and also considered the issue of whether or not the occurrence of a change in control was relevant to the evaluation of whether or not an acquisition constituted an RTO.

Company A was involved in the sale, design and manufacture of toys (the “Original Business”) and conducted an open offer in order to raise funds for general working capital. When this open offer was made, Company A’s chairman and controlling shareholder (“Mr B”) did not avail of the opportunity to take up new shares and as a consequence his interest in Company A diminished from 40% to 8%. He then retired as chairman and as a director. Almost contemporaneously with this, Company A started in the business of property holding and research and the development of electric bus batteries. However, these activities were small in scale and not of great importance to Company A.

Proposed acquisition and disposal

Four months subsequent to the open offer completing, Company A proposed to acquire the Acquisition Target company, which was engaged in the manufacture of solar panels, from the Vendor (the “Acquisition”). This transaction would amount to a very substantial acquisition. Company A also intended to sell the Original Business to Mr B (the “Disposal”), with this transaction amounting to a very substantial disposal and also being contingent on the completion of the Acquisition. The rationale behind the Acquisition and Disposal, according to Company A, was that the former would allow it to commence business in a new high growth area and the latter would permit the realisation of its investment in what was a loss making venture. Company A claimed that the Acquisition did not amount to an RTO under Rule 14.06(6) due to the fact that:

  1. there would be no change of control of Company A (as defined in the Takeover Code) as a consequence of the Acquisition and the Disposal; and
  2. the controlling stake in Company A had not changed hands in the 24 months before the agreements for the Disposal and Acquisition completed (Listing Rule 14.92 states that a listed issuer which disposes of its current business in the 24 months subsequent to a change in control will be treated as a new listing applicant).

The Exchange’s Analysis

The two bright line tests for RTOs detailed in Rule 14.06 (6) are not exhaustive, and transactions effectively amounting to backdoor listings can be treated as RTOs. The Exchange accepted that the bright line tests did not apply in this case as the Acquisition would not result in a change in control, nor did the Vendor take control of Company A within the 24 month period before the completion of the Acquisition.

However, if the Acquisition was viewed by the Exchange as an RTO under Rule 14.06(6), and furthermore as an extreme case, then the initial listing requirements would apply to the acquisition. In evaluating whether or not this was the case, the Exchange took the following into account:

  • the consequence of the Acquisition and Disposal would be a complete change in the business undertaken by Company A. The outcome of the transactions, when taken together, was that Company A would sell the Original Business to Mr B, while acquiring a whole new business from the Vendor and effectively listing it.
  • the Acquisition Target had no trading record and was not capable of meeting the profit test for new applicants detailed in Rule 8.05 (1)(a).

The Exchange stated that the argument advanced by Company A, that the Acquisition could not be an RTO, as it would not cause a change in control (under the Takeover Code), was irrelevant. The Exchange highlighted the definition of an RTO under Rule 14.06 (6), which is an acquisition which the Exchange believes to be an attempt to list the assets acquired and circumvent the new listing requirements.

After considering the above factors, the Exchange found that the Acquisition was a component of a series of transactions designed to circumvent the obligations placed on new applicants and was also an extreme case. The listed issuer was therefore treated as a new listing applicant.

Listing Decision LD57-2013

Another extreme case of an RTO that did not meet the bright line tests in Rule 14.06(6) is Listing Decision LD57-2013. The Main Board listed issuer in this case (“Company A”) attempted to acquire half of the share capital of the target company (“Target”) in consideration of cash, consideration shares and convertible bonds. The consideration shares and convertible bonds issued would have comprised 180% of Company A’s existing share capital, but the terms of the convertible bonds would not allow a conversion which would trigger a mandatory general offer under the Takeovers Code. The acquisition would have constituted a very substantial acquisition according to size tests. The Target’s principal business was entirely different from those of Company A and following completion, the Target’s shares would be accounted for as an interest in an associated company or an investment in Company A’s financial statements.

The Exchange’s Analysis

Neither of the bright line tests under Rule 14.06(6) applied; the transaction would not have resulted in a change in control under Rule 14.06(6)(a), nor would the target company have gained control of Company A within the 24 months prior to completion of the acquisition as required under Rule 14.06(6)(b). However, the Exchange concluded that the acquisition would be an RTO in essence for the following reasons:

  • Not only would the transaction be a very substantial acquisition, but on completion, Company A’s existing business and assets would be relatively immaterial to the enlarged group; and
  • Neither the assets being acquired nor the enlarged group could meet the requirements of Rule 8.05(1), which requires new listing applicants to have a trading record of:
    • three financial years;
    • HK$20 million in profits for the most recent year; and
    • HK$30 million in profits (in aggregate) for the preceding two years.

Company A argued that the enlarged group would satisfy the profits test under Rule 8.05(1), but the Exchange determined that the Target’s trading record should not be included for the purposes of the Rule since Company A would account for the assets being acquired as an interest in an associated company or an investment. Company A had recorded losses in the years before the proposed acquisition and the enlarged group (excluding the shares in the Target) could not meet Rule 8.05. The Exchange considered this to be an extreme case of an RTO. The acquisition did not meet the bright line tests under Rule 14.06(6), but as a transaction intended to list the shares in the target while circumventing the listing requirements, it was nevertheless an RTO in essence.

Listing Decision 95-4 on Application of the RTO Rules to Extreme Cases

In this Decision, released in July 2010, the Exchange was tasked with assessing whether or not a company’s proposed acquisition should be regarded as an RTO under Rule 14.06 (6). It also considered the effect of both the old and new Chapter 18 Rules.

The company (“Company A”) was engaged in the sale of machinery and equipment (the “Existing Business”) and proposed to acquire a company (the “Target”) from an independent third party (the “Vendor”), in a transaction constituting a very substantial acquisition. The Target was active in the oil and natural gas exploration, extraction and processing sectors. It held exploration and extraction rights in two gas fields, with one being in the preliminary exploration stage and exploration yet to commence on the other. However, Company A intended to continue the Existing Business after the Acquisition.

Main Board Rule 18.02(1)

This Rule was part of the pre-June 2010 regulatory framework for mineral companies, which was in force at the time of this case. It stated that an application for listing from a company whose current activities consist solely of exploration will not normally be considered by the Exchange, save where the issuer is able to demonstrate “the existence of adequate economically exploitable reserves of natural resources, which must be substantiated by the opinion of an expert, in a defined area over which the issuer has exploration and exploitation rights.”

The Exchange’s Analysis

In classifying the Acquisition as an RTO under Rule 14.06(6), the Exchange was swayed by the following factors:

  • the Acquisition met the requirements for classification as a very substantial acquisition, and, in terms of scale, would be significant for Company A. After the Acquisition, the Target’s business would represent a considerable portion of Company A’s business, and would involve an activity totally different from the Existing Business. The Exchange concluded that the Acquisition was a method of achieving a listing of the Target’s business.
  • the Target had generated no revenue at the time when the Acquisition was due to take place, meaning that it could not meet the profit test for new applicants in Rule 8.05(1).
  • the Target fell within the classification of an early stage exploration company, as described in Rule 18.02(1), and was unsuitable for listing as Company A failed to demonstrate that the gas fields had the required reserves.

The Exchange also noted that even had the current Chapter 18 been in effect, the Target would still have been unsuitable for listing, as it would not have been able to show that it had a portfolio of identifiable resources (i.e. for oil and gas companies, Contingent Resources as defined in the new Chapter 18).

The Exchange finished by stating that the proposed Acquisition was a transaction aimed at achieving a listing of the Target’s business and circumventing the requirements for new listings. It was an extreme case and must be viewed as an RTO under Rule 14.06 (6).

JULY 2014

This note is provided for information purposes only and does not constitute legal advice. Specific advice should be sought in relation to any particular situation. This note has been prepared based on the laws and regulations in force at the date of this note which may be subsequently amended, modified, re-enacted, restated or replaced.

Reverse takeovers

Hong Kong Listing Rules

Very substantial acquisition

Extreme very substantial acquisition

Hong Kong Takeovers Code

Backdoor listing

Stock Exchange of Hong Kong

Reverse takeover rules

Reverse IPO

Examples of takeovers

Corporate acquisition
Mergers and acquisitions


Skills

Posted on

2014-06-15