Reverse Takeover and Backdoor Listing (Part 1 of 3)


Forget the front door, let’s go in the back

Reverse takeovers and backdoor listings remain a grey area to the investing public. An RTO is the manner by which a private company achieves a listing on the Hong Kong stock market without making an initial public offering on a road show. Previously, industry practitioners would hush among themselves on the market rate or ‘premium’ listed company shells in Hong Kong are looking to be sold for.

The current premium on listed shells in Hong Kong ranges from HK$300-600 million. By the rule book, this premium is then injected into the net asset value of the company.

The issue of RTOs has existed since the early 1990s when companies from Mainland China, mostly state-owned enterprises, would attempt a listing on Hong Kong’s stock market. Back in the 1990s, a listing in Hong Kong showed overseas investors signs that Chinese companies were becoming of sound management and transparent accounting. This is yet to be seen as over two hundred Chinese companies have achieved listing in the US, by the way of RTOs, and shortly thereafter more than two-thirds have been delisted or its shares suspended.

There are two stock exchanges in Hong Kong: Main board and Growth Enterprise Market (GEM) board. While the rules for the Main and GEM board are near identical, the GEM is designed for smaller listed companies and is positioned to investors as “buyers beware” due to the higher investment risk. A listed company in Hong Kong must meet requirements set by the stock exchange, Hong Kong Exchanges and Clearing Limited (HKEx), and stock market regulator, Securities and Futures Commission (SFC).

In principle, the HKEx is the stock exchange regulator and the SFC is the stock market regulator.

The HKEx and SFC look to enforce the RTO rules with the goal to achieve the following. Firstly, in order to maintain the merit of its financial market, HKEx and the SFC must ensure that companies do not circumvent the stock market listing rules (SMLR) as set out in the Securities Futures Ordinance (SFO).

Secondly, RTO rules aim to protect the interests of minority shareholders. If a minority shareholder purchased shares in a natural resources miner but following a company announcement, its management decides that, in the best of interest of ALL shareholders, it would dispose of its natural resource business and diversify into financial services – minority shareholders would be left with shares in a company with management expertise in natural resources running a financial services company, the new business. The new business line would have entirely different business risks and revenue segments associated with the priced originally paid for the shares in the natural resources company.

RTO within the Bright Lines

By definition, the SFO defines RTOs under Chapter 14, Notifiable Transactions, as Main Board Rule 14.06(6) and GEM Rule 19.06(6). It is defined as:

An acquisition or a series of acquisitions of assets by a listed issuer which, in the opinion of the Exchange, constitutes, or is part of a transaction or arrangement or series of transactions or arrangements which constitute, an attempt to achieve a listing of the assets to be acquired and a means to circumvent the requirements for new applicants set out in Chapter 8 of the Exchange Listing Rules.

The HKEx Listing Committee can apply the “Bright Line Tests” to an RTO in two non-exhaustive instances (transactions):

  1. An acquisition (or series of acquisitions) of assets constituting a very substantial acquisition (VSA) which results in a change of control (defined in the Takeovers Code as 30%) of the listed company; or
  2. An acquisition(s) of assets from a person or a group pursuant to an agreement entered into by the listed company within 24 months of such person or group gaining control (as defined in the Takeovers Code) of the listed company (other than at the level of its subsidiaries), where such gaining of control had not been regarded as a reverse takeover, which individually or together constitute(s) a very substantial acquisition.

In addition to the Bright Line Test, the RTO can be applied by the Listing Committee as a principle based test. For example, if a listed company disposes of its existing business and, presumably with the proceeds, acquires a completely new business line, this will be regarded as an RTO even if there is no change of control (owning > 30%).

On a discretionary basis, a waiver can be granted, by the Listing Committee, if a listed company performs a VSA of a business line closely related to its principal business (e.g. property developer acquiring a construction company).

A waiver to the RTO would not be granted if it were determined that the listed company was a listed shell.

This waiver is granted when the Listing Committee is confident that the listed company is not circumventing the Listing Rules. Upon granting of the waiver, the HKEx insists on a circular to its shareholders with an enhanced level of disclosure in respect to the decision made and reasons for the acquisition.

One potential scenario to note here is the VSA and RTO of a mineral or petroleum asset. In both instances, the listed company would be deemed a “Mineral Company” for the purposes of the Listing Rules. This means the new business will be subject to Main Board Rule 18.11 and GEM Rule 18A.11, in addition to the basic listing conditions of a non-Mineral Company.

Should it view a transaction as circumventing the Listing Rules, the Listing Committee has the discretion to decide whether or not the transaction is an RTO. However, being principle based, the RTO rules can be left open to circumvention by market participants and their esteemed corporate finance advisors. Therefore, should the Listing Committee view a transaction as circumventing the RTO rules, the listed company will be treated as a new listing and will be required to follow the relevant procedures of a new listing.

So if a listed company, following a VSA, is censured to have conducted an RTO, what ensues? First, the now enlarged listed company must ensure it continues to meet basic listing conditions having performed the VSA. Second, the asset in relation to the VSA must meet one of three conditions for listing, under Main Board Rules, by satisfying Listing Committee the asset can meet the profit test in rule 8.05(1) or the market capitalisation/revenue/cash flow test in rule 8.05(2) or the market capitalisation/revenue test in rule 8.05(3).

Under Chapter 14 of the Listing Rules, Notifiable Transactions are subject to the following test:

Transaction Type

 Size Test (revenue, profit, total assets, market cap, nominal share capital) 

Share transaction


Discloseable transaction

≥5%, but <25%

Major transaction – disposal

≥25%, but <75%

Major transaction – acquisition

≥25%, but <100%

Very substantial disposal (VSD)


Very substantial acquisition (VSA)


Reverse takeover (RTO)

VSA + change of control

Third, the listed company must issue a circular to its shareholders containing information on the VSA. This circular must contain the level of information equivalent to that of a new listing applicant. Fourth, an initial listing fee is payable to the HKEx. This fee (displayed below) is non-refundable and expires with the application valid for 6 months. Fifth, the listed company must appoint a sponsor (SFC Type 6 licensed intermediary) to conduct the level of due diligence equivalent to that of a new listing.

Initial Listing Fee Schedule

Initial Fee ScheduleSource: Appendix 8 of Main Board Rules by HKEx

Only upon fulfilling the above five requirements will the Listing Committee consider the listed companies application. If approved, only then will the listed company be able to complete the RTO, which is conditional on shareholders’ approval in a general meeting. It is not cheap to run a listed company, therefore the fees associated with a new listing application will be irrelevant to management who are most concerned with the timeliness in completing the RTO. This is a classic example of ensuring management maintains their cost of capital targets.

RTO outside the Bright Lines

If there is no change of control and a listed company performs a VSA, the Listing Committee will still determine the transaction an RTO if they deem it to circumvent the new listing requirements. This is considered an extreme VSA.

A transaction, which falls outside the bright line test, is vetted by the HKEx using the principle based test. The Listing Committee will assess the transaction based on the following criteria:

  • Size of transaction relative to size of the listed company;
  • Quality of the asset being acquired and whether it is suitable for listing;
  • Nature and scale of the listed company’s principal business prior to the acquisition (pointing to whether the extreme VSA is a listed shell) and assess whether a material change would occur in the company’s principal business;
  • Assess historical events and transactions made by the listed company, which when put together, would form an arrangement to circumvent the RTO rules; and
  • Whether any restricted convertible securities were issued by the vendor, which would eventually put the vendor with de facto control of the listed company.

One reason the issuance of restricted convertible securities is a sticky point to the Listing Committee is because these securities are highly dilutive with a conversion restriction mechanism to ensure the vendor does not hold over 30% in the listed company. If the vendor held over 30%, this would trigger a mandatory general offer (MGO).

The diagram below depicts the routes in which a VSA will pass the Listing Division:

Extreme VSA
Source: Page 4 of HKEx Guidance Letter 78 (May 2014)

Basic Example: VSA within the Bright Line Test

Below example is an example drawn from the HKEx Listing Decision 29 in 2012:

VSA within Bright Line
Source: HKEx Listing Decision 29-2012

Details of the transaction:

  • Above graph: Listco is a Main Board listed company on SEHK, Company B is Listco’s controlling shareholder, Target is a company which Listco proposes to acquire from Company B
  • The issue: Is Listco’s proposed acquisition of the Target from Company B an RTO?
  • Relevant Listing Rules: Main Board Rule 14.06(6)(b)
  • Decision: Transaction was an RTO

Facts about the transaction:

  1. Listco is principally engaged in the property business, while Company B is engaged in various businesses including property projects held through the Target
  2. One year ago, Company B acquired a controlling interest in Listco and accounted for Listco as a subsidiary
  3. It is proposed that Listco acquires the Target from Company B and in return will issue new shares to Company B to settle the consideration (price of purchase and sale)
  4. Based on Listco’s size, the proposed transaction is a VSA and is made within 24 months after a change in control of Listco

Listco submit to the HKEx Listing Division that the VSA should not be classified as an RTO because:

  1. Listco has been engaged in the property business for many years, has substantial business operations and declares not to be a shell company
  2. Listco and the Target are in the same line of business
  3. Transaction is not intended to achieve a listing of the Target’s business. It is intended to reorganize the Listco Group and consolidate Company B’s property business into Listco
  4. Target business can meet profit requirements for new listing applicant, as stated under Rule 8.05(1)

HKEx Listing Division Analysis:

  1. Main Board Rule 14.06(6) seeks to prevent circumvention of the new listing requirements; such that, an acquisition(s) which represents, in the Exchange’s opinion, an attempt to list the asset(s) acquired and circumvent the new listing requirements will be deemed an RTO
  2. In reference to Rule 14.06(6) (a), there was a change of control of the Listco as the injection of asset was significant; and in reference to Rule 14.06(6) (b), the transaction was made within 24 months after a change in control of Listco
  3. For Company B, the transaction was a reorganization of its property business; however, the transaction size in comparison to Listco was material
  4. Therefore, the transaction, together with change of control of Listco, is deemed as a means to list the Target property business
  5. Transaction is an RTO of Listco

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