What is reverse takeover (RTO)?

Reverse takeover (Reversetakeover,RTO), also known as backdoor listing, means that shareholders of non-listed companies control a listed company by acquiring shares of a listed company (shell company), and then reverse acquire the core assets and business of the unlisted company, so as to achieve the purpose of indirect listing. Because shell companies usually have a small volume of business, this process is also vividly referred to as a "snake swallowing elephant".

Usually, these acquisition targets do not have the ability to go public independently, otherwise they would not take this form of "curve saving the nation". Rule 14.06B of the listing rules of the Stock Exchange¹It also points out that reverse takeover has the intention of listing acquisition targets and circumventing the requirements of new listing applications.

What are the criteria for RTO?

According to rules 14.06B and 14.06C of the listing rules, there are three kinds of tests to determine whether they belong to RTO, namely, "clear test", "principle-based test" and "extreme trading test".

• First of all, if the transaction fails the "clear test", it will be immediately recognized as RTO;. If it has passed the "clear test", it will also be subject to the comprehensive consideration of the "principle-based test".

• Secondly, if the "principle-based test" is passed, it will not belong to the RTO;. If it fails, there will be another exemption test, that is, the "extreme trading test".

• Finally, if the transaction is an "extreme transaction", it will be exempted, but the degree of disclosure will need to be enhanced; but if it is not an "extreme transaction", it will be regarded as a RTO.

A, clear test

"clear test" as its name, there are clear quantitative indicators to refer to. If a very significant acquisition occurs at the same time as the change of control (30% or more) or within 36 months, it will fail the "clear test".

The calculation of a major acquisition is to divide the data involved in the acquisition transaction by the percentage of data obtained by the listed company. If the result of any one item is greater than 100%, it is a major acquisition. Among them, the consideration ratio and equity ratio are easier to judge.

B, principle-based test

The principle is that this test is a comprehensive test considered as a whole and has certain subjective judgment components. The SEHK will take into account the following six factors.

1. The scale of acquisition is relative to that of listed companies.

If a listed company makes a large-scale acquisition so that the existing main business is no longer important after the completion of the transaction, it may be judged as RTO. The SEHK does not set an absolute limit and needs to be taken into account in the light of other assessment factors.

2. Whether there is a fundamental change in the main business of listed companies

According to the guidance letter of the SEHK, "fundamental change" does not refer to business related to the existing business development strategy of listed companies, nor does it include acquisitions commensurate with the size of listed companies. For example, if it is the integration of the industrial chain expanding upstream and downstream, or diversified development, it does not belong to the "fundamental transformation".

3. The nature and scale of the previous business of the listed company

If the existing business of a listed company is small or has the characteristics of shell stock, it is easier to be regarded as RTO when making a major acquisition.

4. The quality of the acquisition target

Whether the subject matter of the acquisition itself meets the qualifications for new listing.

5. Change of control or actual control

6. A series of transactions or arrangements intended to list the acquisition target (usually within 36 months)

The SEHK usually takes items 5 and 6 into consideration. For example, investors may purchase significant shares in listed companies, appoint new directors to the board of directors, and then acquire new businesses. Moreover, the new directors have no experience in the existing business of listed companies, but they have expertise in new businesses acquired by listed companies. Such a series of transactions or arrangements may refer to RTO rules.

It is worth noting that if a deal for a new business is proposed just 36 months after the change of control, the deal may be considered planned within 36 months, or it may be regarded as RTO.

C, extreme trading test

If it fails the "principle-based test", the SEHK has set up an exemption case, the "extreme trading test".

Unfortunately, as the name suggests, the "extreme trading" test is more difficult to satisfy:

1. Listed companies cannot have the characteristics of "shell shares".

2. In the 36 months prior to the acquisition, there was no substantial change in the control and there was no series of transactions or arrangements intended to list the acquisition target.

3. Listed companies have a large scale of main business (annual income or total assets are more than HK $1 billion) and will continue to operate main business after the acquisition.

4. The acquisition target must comply with Article 8.05 of the listing rules (including profit testing).

Summary

To determine whether it belongs to RTO, you need to pass the three tests, including "clear test", "principle-based test" and "extreme trading test". Among them, the "principle-based test" has more subjective and comprehensive considerations, and it needs to be more cautious in the transaction to avoid being judged as RTO.

What will be the consequences if it is unfortunately recognized as RTO? In the next article, we will introduce the first case that has been punished by the new law of RTO-- the founding group 1609.HK.