I’m your mamma
I’m your daddy
I’m that nigga in the alley
I’m your doctor
when in need
want some coke?
have some weed
You know me
I’m your friend
your main man
thick and thin
I’m your pusher man
I’m your pusher man
From the song, Pusherman, by Curtis Mayfield, (click here to listen)
Every few months I get a call from a lawyer or an “investment broker” telling me of the great riches that await me for referring them China securities work. These people are always with firms of which I am not familiar and though they usually do not come right out and say it, they are pitching me on reverse mergers. I tell them if I hear of anything “up their alley,” I will let them know.
I never really do hear of Chinese companies doing reverse mergers for pretty much the same reason I do not hear of crack deals going down: I generally try to avoid those sorts of things.
Peter Fuhrman of The China Private Equity Blog recently did a post entitled, “The Reverse Merger Minefield,”appropriately slamming China reverse mergers,
According to Fuhrman, 380 Chinese companies have executed reverse mergers in the US since 2005 and almost all did so “as a first step towards getting listed on a major US exchange, most often the NASDAQ.” Yet, “only 15% of those Chinese companies successfully ‘uplisted’ to NASDAQ. That’s a failure rate of 85%.” Furhman rightly sees this abysmal record as an “indictment” of those out pushing these reverse mergers to Chinese companies:
That’s a rather stunning indictment of the advisers and bankers who promote, organize and profit from these transactions. The Chinese companies are left, overwhelmingly, far worse off than when they started. Their shares are stuck trading on the OTCBB or Pink Sheets, with no liquidity, steep annual listing and compliance fees, often pathetically low valuations, and no hope of ever raising additional capital.
The advisors, on the other hand, are coining it. At a guess, Chinese companies have paid out to advisors, accountants, lawyers and Investor Relations firms roughly $700 million in fees for these US reverse mergers. As a way to lower America’s balance of payments deficit with China, this one is about the most despicable.
Despite the poor record of these mergers, “US firms specializing in reverse mergers are a constant, conspicuous presence as sponsors at corporate finance conferences around China, touting their services to Chinese companies,” always with the same pitch: “we can get your company listed on NASDAQ.”
I love Fuhrman’s description of how these reverse merger pushers (my word not his) operate:
I have no doubt these firms know that 85% of the reverse mergers could be classified as expensive failures, because the companies never migrate to NASDAQ. Equally, I have no doubt they never disclose this fact to the Chinese companies they are soliciting. I know a few “laoban” (Chinese for “company boss”) who’ve been pitched by the US reverse merger firms. They are told a reverse merger is all but a “sure thing”. I’ve seen one US reverse merger firm’s Powerpoint presentation for Chinese clients that contained doctored numbers on performance of firms it brought public on OTCBB.
Accurate disclosure is the single most important component of financial market regulation. Yet, as far as I’ve been able to determine, the financial firms pushing reverse mergers offer clients little to no disclosure of their own. No other IPO process has such a high rate of failure, with such a high price tag attached.
Though the Chinese companies that are suckered are at least somewhat responsible for their own fate, “just because someone wants a vacation house in Florida doesn’t make it OK to sell them swampland in the Everglades.“
Fuhrman sees these reverse mergers as damaging to China and he would to see them curtailed:
The reverse mergers cost China dear. Good Chinese SME are often bled to death. That hurts China’s overall economy. China’s government probably can’t outlaw the process, since it’s subject to US, not Chinese, securities laws. But, I’d like to see the Chinese Securities Regulatory Commission (?????), China’s version of the SEC, publish empirical data about US reverse mergers, SPACs, OTCBB listings.
There is not much that can be done for the 325 Chinese companies that have already completed a US reverse merger and failed to get uplisted to NASDAQ. They will continue to waste millions of dollars a year in fees just to remain listed on the OTCBB or Pink Sheets, with no realistic prospect of ever moving to the NASDAQ market.
For these companies, the US reverse merger is the capital markets’ version of ??, or “death by a thousand slices”.
In a subsequent post, entitled, ”Reverse Mergers — Knowledgable Comment,” Fuhrman extols a comment by one of his blog readers on the numbers that make reverse mergers such a bad way to go:
A Reverse Merger (”RM”) is routinely pitched as a cheaper and quicker method of going public than a traditional IPO in China. This may be technically true but the comparison is VERY MISLEADING.
As you mentioned a few times in your blog, an RM is not a capital raising transaction. No shares are sold for cash in the transaction. It will receive little attention from analysts! The RM is often coupled with a PIPE financing. However, the amount of PIPE financing that can be raised is very limited. Additionally, PIPE financing is typically expensive relative to other financing options and may contain onerous terms.
Generally, completing a $50 million IPO will roughly run a company 18% of the offering proceeds, including underwriter discounts, under pricing, and legal, accounting, filing, listing, printing, and registrar fees, or $9 million.
Conversely, an RM was advocated as “costs only between $100,000 and $400,000 to complete”. This is the most tricky and misleading part, because this cost range does not include the value of the equity stake retained by the shell promoter and its affiliates. And most Chinese company does not understand this.
Generally when the RM closes, the Chinese Operating Company is issued Shell Company shares only equal to 80% to 90% of Shell Co’s post-merger outstanding shares. The the remaining 10% to 20% of shares are retained by the owner of the Shell Company, the promoter and its affiliates.
Hence, in addition to the $100,000 to $400,000 in cash paid by Chinese Operating Co to complete the RM, the Chinese Operating Co has also “paid” a 10% to 20% stake in its company. If the market capitalization is $50 million post-RM, this stake is worth $5 to $10 million.
So RM is not cheaper at all! It is Usually an option for second and third tier companies to obtain financing via a PIPE, and some PIPE investors may not be long-term investors. An active trading market for stock may not be developed through a RM. Company will probably not qualify to trade on the Nasdaq and will likely end up trading in the pink sheets or the bulletin board.
Spread the word.
