Reverse Takeovers: A shell game
by Ian Rowley

Make no mistake—reverse takeovers might seem like a handy way to get a stockmarket listing, but they can be devilishly difficult.
Ian Rowley

When Integration, a £4.7m (E7.7m) privately owned UK computer-services company, began looking for additional funding for its fast-growing application service provider (ASP) business last summer, it hit a wall.

First, the company decided against turning to venture capital for fear of losing management control. Second, and perhaps more important, an initial public offering was out of the question as technology stocks continued their freefall.

Then executives at Integration took a look at reverse takeovers. Though the notion is not new, reverse takeovers—where private firms acquire listed companies—are attracting interest in many business circles. One of the main drivers is the shakeout in the dot-com sector. The idea is that failing dot-coms that have floated can woo potential buyers with the prospect of rapid access to a stock listing. The buyer also has access to the dot-com’s liquid assets. But reverse takeovers aren’t just used for dot-coms.

At Integration, Eamus Halpin, its chief executive, opted to do a reverse takeover of SEP Industrial Holdings, a struggling old economy producer of metal holders and fasteners, which had floated in London in the late 1980s. “After looking at the deal in great detail, we signed exclusivity in December,” says Halpin, at which point SEP’s shares were suspended until the deal was finalised, subject to shareholder approval, in late June.

Timely advice

The deal—which lets Integration acquire SEP’s stockmarket listing and its £1.4m cash balances—is valued at £15.5m. The combined company, now called iRevolution, is also raising £9.3m net of expenses by issuing new stock.

But while reversing into a cash shell may seem attractive at first glance, investment experts warn that they can be tricky. They note that reverse takeovers are at least as time consuming as an IPO and usually more complex. “A reverse takeover can take anything from six to nine months to complete,” says John Harley, global head of technology, media and telecoms for the corporate finance group at Ernst & Young. “You have to effectively re-list the company.”

So as the reverse buyer is taking care of the due diligence on the shell company, it will also have to begin channelling much of the information required for an IPO—such as both companies’ profit histories—to stock-exchange authorities and produce a prospectus.

Chris Prevett, Integration’s finance director, concedes that he was surprised by the amount of time that a reverse takeover takes. “The quantity of disclosure required is out of this world,” he says.

Others who have attempted reverse takeovers would second that. Executives at Microboss, a German technology group, got a big jolt after getting some harsh news from Deutsche Börse in January this year. Authorities at the exchange reminded them that they would first have to fulfil the same requirements as any other company going through an IPO if the firm went ahead with a planned reverse takeover of Gigabell, an online dating agency with a listing on Germany’s Neuer Markt. By February, Microboss and Gigabell decided to go their separate ways.

Meeting exchange requirements isn’t the only challenge, of course. “There are lots of potential difficulties,” says Philip Kendall, head of the PLC advisory at PricewaterhouseCoopers. Notably, companies considering reversing into a listed firm should look carefully at the profile of the shell’s shareholders. Kendall notes that private investors often dominate a shell’s investor base, particularly if institutions sold out when the business began running into trouble. “The last thing you want is 3,000 penny investors,” he says. (Halpin says that isn’t the case with Integration’s deal, noting that SEP’s shareholders are predominantly institutional.)

Then there is the same host of post-deal integration issues typical of traditional takeovers that must be addressed. For example, he notes, “there are two sets of management teams and you’ve got to get rid of one of them”.

According to Integration’s Prevett, its deal hit another speed bump. SEP needed time to turn its assets into cash. Over its 20-year history, SEP had built up a range of capital-intensive subsidiaries, most of which had to be liquidated before the deal with Integration could go ahead. “We wanted to make sure we were reversing into a very clean company,” he says, noting that it took SEP until the end of March to sell most of the business divisions, such as Component Industries, which was liquidated via a management buyout for £4.5m. “If you’ve got a clean cash shell [at the outset] that speeds up the whole process,” Prevett adds.

Despite the drawbacks of reverse takeovers, Integration’s Halpin reckons that there will be more of them in the coming months—particularly as failing dot-com companies with sizeable cash reserves seek new futures as shell companies.

“The reason I think we haven’t seen many deals happening so far is because it takes a while to be turned into a shell,” he says. “To do that properly takes time.”

And, if Integration’s transaction is any guide, a lot of hard work.