Hong Kong’s red-hot corporate shell game is cause for concern
More than 40 per cent of the 22 companies listed on the main board in the past three months are likely to be shells
In vetting an application for listing, we should consider its suitability. It is not about whether it meets the listing and profit requirements but the motive behind.
Securities and Futures Commission chairman Carlson Tong
A motive is like love: hard to quantify and define. When a regulator tries to bring it in, he is truly angry.
Tong was roaring at “shell planting” – the red-hot business of listing a company in order that it can be sold for a future back door listing.
He has reason to.
If motive can be quantified by some circumstantial evidence, more than 40 per cent of the 22 companies listed on the main board in the past three months are likely to be shells.
The nine companies share some strikingly similar characteristics. Foremost is the small sum they have got from the listing.
Their net proceeds range between HK$70 million and HK$185 million. For that, they paid broker, lawyer and auditor fees of 15 per cent to 62 per cent. Fundraising can hardly justify the hefty bills.
The reality is a market capitalisation of between HK$400 million and HK$700 million synchronises with the market price of a shell nowadays.
It also minimises the money a shell owner needs to fill up the share orders when there is no public demand or to suck up the public flow when there is.
Second, they all have one private shareholder controlling more than 55 per cent and single business with little in the way of assets, making it easy to dispose of in the future.
Third, all but one reported mounting trade receivables and cash flow concerns.
One company reported a 30 per cent increase in sales and a doubling in amount due from customers between 2012 and 2014, resulting in negative cash flow.
They explained that away with the economic slowdown. Yet, any accountant knows receivables can be the result of inflated sales and profit.
After all, it is not easy to find a perfect business that meets all the listing requirements.
That leads to another common feature among five of the companies – a high dividend payout before listing.
One company paid a HK$240 million dividend before raising HK$100 million from the public offering. Another handed out a HK$60 million dividend and got HK$70 million from the listing.
Why bother listing when you have a lot?
In the case of inflated profit, dividend is good in explaining the whereabouts of cash earned from the ever-growing business to an auditor.
In the case of some real profit, a generous dividend would trim the asset size, making the shell more digestible for the future buyer.
There should be no worries about the inflated numbers being caught. A year later the owner is going to sell the shell to a buyer who knows about it and then buy back the “ever-growing” business. No one is going to tell.
Lastly, most of their Hong Kong-based independent directors also sit on the board of various listed shells.
In one case, two of the three independent directors play the same role in a GEM-listed company.
Apparently, there is a shortage of “knowledgeable” directors to satisfy the surge in shell companies.
Multiply this estimate with the price tag of a listed shell, and one can see how HK$4.5 billion worth of assets has been created in the past three months.
Count in those newly listed on the GEM board, where requirements are lax and no public offering is required, and it is a feast with more to come.
“When is my turn?” is the most popular exchange in the IPO cocktail circuit nowadays.
Some say regulators should leave them alone because nobody’s hurt.
It’s like asking for casinos to be left uncontrolled. With the gaming pits comes all the vice. With the shell-planting business comes all the manipulation and fraud.
It is not about whether the shell planting or share sale should be allowed.
It is about whether the companies mentioned above are fit for listing on their fundamentals.
It is about whether businesses should be allowed to list without proper scrutiny by going through the back door.
There is not much time for waiting. The big money is pushing things fast.
The genuine public float in one of the nine companies is largely dried up, according to the commission’s announcement. Twenty individuals now control 87 per cent of the company, the first step to a shell sale. That is only three weeks after its listing.