Reverse merger concept may find takers in India

By siliconindia   |   Wednesday, 19 December 2007, 01:30 IST
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The trend of reverse merger as a means to gain listing could just be gaining momentum. Some cases of the past two weeks can be taken as a proof. A six years old outsourcing company, which employs150 people, is receiving investment from an U.S. based PE fund which is also making this company merge with a listed company, reported The Economic Times. Another small Mumbai based construction services company, with FY07 revenue of 12.5 million, has been approached by a PE fund with intend to reverse merge. Though these two instances need not make a trend. However, the reverse merger as a method of listing and followed by raising public capital is a phenomenon waiting to pick up. If it can achieve serious scales in the U.S. and China, there is no reason why it cannot pick up in India. There have been expectations even in the past one to two years that reverse mergers will gain ground in India. "Perhaps because it is easy to do an IPO in India," said Bhavesh Shah, JM Financial Executive Director. From the perspective of a PE fund, a reverse merger remains an attractive option. It provides instant liquidity. It is not easy for an around $10 million turnover company to go public. The cost of the issue, and the pricing you could command could both make it unattractive. If the issue devolves, it is a serious loss of face. If the promoter, PE or the merchant banker has to bail the issue out, then instead of providing liquidity, the issue could do exactly the reverse. "While reverse merger route has merits, it is open to abuse. For a good company, we would still advise a private placement or an IPO," says Sharad Rathi, Almondz Global Securities Head (investment banking). Reverse mergers are far more popular in the U.S. There have been about 200 reverse mergers per year since 2004, according to DealFlow Media, a U.S. based outfit tracking alternative investments. As many as 150 Chinese companies are believed to have listed in U.S. through this way in two years, according to a Business Week article. Most of these reverse mergers happen where a normal operating, but unlisted, company merges into a listed shell company. In the merger, the operating company's shareholders are issued shares of the shell in exchange for the operating company's shares. After the merger, the former operating company's shareholders own 85 to 95 percent of the shell, which now contains the assets and liabilities of the operating company, with the remaining 5 to 15 percent owned by the existing shell company's shareholders. These shell companies are often companies that have either gone bankrupt or ceased to do business, but have retained their listing. The risk with such companies is that there could be hidden liabilities, lawsuits or collection agents waiting for the former public shell company to gain assets that could be seized. The new entity could become responsible for those liabilities. There are investment banks in U.S. specializing in shell creation and reverse merger. They regularly create pure shells and other special purpose acquisition companies.