What is an RTO (Reverse Takeover)

2023.01.18 2023.01.18
Reverse IPO

Oleg Tkachenkohttps://www.litefinance.org/blog/authors/oleg-tkachenko/

A public company is a company that has been listed on a stock exchange. Its stocks are freely traded on the exchange and over-the-counter markets. A company can become public through an IPO (initial public offering), which involves several stages:

• Preliminary valuation of the business and determination of the future value of the shares (lasts several months).

• Preparatory stage. Working with underwriters (investment banks).

• Main stage. Collecting applications from potential buyers.

• Final stage. Listing of the company on the stock exchange.

IPO is a rather expensive and lengthy procedure. Therefore, some private companies choose reverse takeovers (RTO). In this article, you will learn about the RTO concept, its types, advantages and disadvantages, and how it affects minority shareholders.

What is Reverse Takeover (RTO)?

A reverse takeover is a merger model in which a private company goes public and gains control over a public company. In other words, a publicly traded company absorbs a private one, but the absorbed one becomes the basis of the new organization. Thus, a private company can buy a controlling stake in a public one, or a public company can buy shares in a private company and carry out a restructuring with rebranding.

Reverse absorption is based on two principles:

• It doesn’t matter which company carries out the reverse takeover RTO. The main thing is that after the procedure, the public company disappears and is replaced by a private company.

• After the RTO, the public company acquires a part of the private company’s assets, the management of which takes full control. At the same time, the stocks of the reorganized company can be traded on the stock exchange.

A public company in this model is often called a shell company. After the transaction, it retains only the organizational structure.

The most common type of reverse takeover is the SPAC deal. SPAC is a shell company with no history of activity and revenue performing a technical role. When carrying out an IPO, SPAC attracts investors who do not know what business they will invest in. The SPAC then buys back the private company’s shares and is liquidated. As a result, the ticker of stocks on the SPAC exchange changes to the ticker of the purchased company.

In this case, a publicly traded company buys a private one. But the essence of the merger remains, the public company ceases to exist, and a private company takes its place.

How Does a Reverse Merger Work

The reverse takeover involves a partial or full share buyback, a partial or full exchange of shares, or the transfer of assets of a private company to the ownership of a public one.

Several options are possible:

• As a result of the merger, the business of a private company passes into a listed company, completely taking its place. A private company obtains a license, the legal address of a publicly registered company, and its listing on stock exchanges. As a result, a new organization is created based on a private owner’s business.

• The assets of a private company become the property of a public company while the private company continues to exist. One of the organizational structures receives the status of a subsidiary, depending on who received the controlling stake.

The ultimate goal of a reverse takeover RTO for a private business is to issue stocks to the public on the stock exchange and attract capital from outside investors.

Different Forms of the Reverse Takeover (RTO)

There are three forms of reverse takeover:

• Classic takeover. The shell company buys a private company, then transfers all shares and management rights to the owners of the private company. This is how SPAC takeovers work. In this case, the newly reorganized company receives the debt obligations of the acquired business.

• Exchange of securities for assets. The shell company buys the assets of a private company and transfers its shares as payment. Assets are transferred to the listed company, while the private company’s shareholders receive a controlling stake, that is, control over the business. In this case, the debts remain with the private structure, and the business is built based on a shell company.

• Exchange of securities. The shareholders of the shell company become the owners of the private company. At the same time, private business owners take control of the shell company and continue to develop the business based on it.

In practice, the reverse takeover process looks much more complicated. Depending on the capitalization of both companies, share exchange ratios are calculated, and an additional issue or buyback (repurchase of shares from minority shareholders) is carried out.

Reverse Merger Examples

Compared to an IPO, it is relatively rare for companies to carry out a reverse takeover since this method does not allow attracting investments at once. But many examples of RTOs have contributed to the emergence of large public corporations.

1. New York Stock Exchange

In 2006, the New York Stock Exchange completed a merger with the public platform Archipelago Holdings and, for the first time, offered its shares to investors under the NYSE ticker.

2. Burger King

In 2012, Bill Ackman, founder and CEO of hedge fund Pershing Square Capital Management held the IPO of shell company Justice Holdings. The investors’ money was invested in the purchase of Burger King Holdings Inc. The company formed due to the reverse merger continued to operate under this name.

3. Dell

In 2013, founder Michael Dell took Dell, Inc. private through a share buyback (75%) at the expense of an investment company ($25 billion). As a result, the corporation turned from a listed company into a private one. In 2018, Dell’s debt rose to $52 billion. A repeat IPO would not make sense, as underwriters (investment banks) would not give a high rating to corporations with such debts. Therefore, a reverse takeover was carried out. VMware (DVMT) bought Dell and reorganized it into Dell Technologies. VMware continued to exist in parallel, and Dell Technologies shareholders received 0.44 shares of VMware each.

Reverse takeovers – the potential benefits

This section discusses the RTO benefits for private businesses interested in becoming public companies.

1. No registration required

After the reverse takeover RTO, the company goes through a change of ownership and management of the company, as well as rebranding, so there is no need to register a new organization. The shell company is already registered and has passed IPO. As a result, it complies with all legal regulations. A private company merges into the structure and becomes public.

2. Saving money

• When attracting investors. An IPO involves a combined issuance of shares and the attraction of investors. This procedure involves several complex stages involving underwriters, stock exchanges, regulators, and other organizations. Through RTO, a company can go public without attracting private capital, which simplifies and reduces the cost of this process.

• During registration and legal paperwork. In the US, if the shell company is registered with the SEC, the private company does not need to go through a costly and lengthy process of checks and approvals with federal and regulatory authorities after the merger. A foreign company can enter the US stock market without a registration procedure.

• In marketing. Attracting investors and brand promotion, which increases the value of shares, are additional costs. At the time of the RTO merger, advertising costs are not required.

3. Saving time

Going public through an IPO can last from several months to a few months to a year. The most time-consuming stage is the preparatory one. It includes a comprehensive assessment of the business, its organizational structure, capitalization assessment, and the calculation of the number and value of shares. RTOs are held throughout the month.

4. Integration into international markets and corporate simplification

There have been cases where a parent company has conducted RTOs of its subsidiaries or gained control of a smaller public company to enter the international capital markets under its own brand. RTO avoided the need to restructure the business to meet local legal requirements.

Such a restructuring was carried out in 2011 involving Russian Polyus Gold and the public KazakhGold company (registered in Jersey, UK), whose 50.1% stake was owned by a Russian gold mining company. The deal simplified Polyus Gold’s organizational structure and provided UK registration. As a result, it could be used as a means of payment in international transactions. After the RTO, the new public company was named Polyus Gold International Ltd.

5. Resilience to changing market conditions

When conducting an IPO, there is a risk of choosing the wrong time for listing. The organization of this process takes several months, during which market conditions can change dramatically. A long decline may follow an uptrend, and competitors will launch a more successful product while potential investors will change priorities. There is also a risk that the underwriter will withdraw its offer during the IPO process. The RTO takes place over several weeks, after which the newly formed publicly traded company is ready to withstand any market risks.

Reverse takeovers – the potential drawbacks

Let’s look at the disadvantages and potential risks that an RTO organizer may face.

1. Legal issues and debts

Depending on the RTO process, the risks of a company having debt obligations, involvement in litigation, and other legal issues that may affect the reputation of the restructured business and the value of shares, remain.

2. Fraud risks

Any merger is preceded by a comprehensive financial analysis to clarify the following points:

• Is RTO reasonable? Will its results outweigh the costs and possible risks?

• How suitable is the second company for the merger? To what extent do its organizational structure and financial turnover correspond to the ideas and policies of the main business?

• Are there reputational risks for future business?

In this case, the SPAC absorption model is again the best. If there is no activity, then there is no financial reporting, litigation and reasons for fraud. If the company is operating, there are dozens of ways to make attractive reporting and conceal the true state of affairs.

3. Market risk

The main purpose of an IPO is to attract investors through a public offering of shares. The purpose of an RTO is to go public quickly and with minimal costs. However, how will investors react to the merger? The news about the RTO could lead to a sell-off of shares of both companies. On the other hand, if the value of shares goes up after the acquisition, then speculative investors can sell them; as a result, their rate will fall. Therefore, carrying out an RTO, you must be confident in the company’s financial strength and its operational and financial attractiveness.

4. Administrative risk

After the RTO, the organization expands its capabilities and geographic reach. A private company most often represents the regional market. After entering the stock markets, its shares become available to investors from all over the world. The company becomes international and must comply with the legislation and criteria of the exchanges of the country where the shell company is registered. The main question is whether the management will be able to cope with a higher-level task. Will inefficient company management lead to stagnation?

Below is a comparison table of IPO and RTO.

Conclusion

• RTO is the transformation of a private company into a public one by gaining control over a company whose shares are already listed on the exchange market.

• The most popular RTO model is the SPAC merge. A shell company without a type of activity carries out an IPO and then invests the attracted money of investors in a private business. After the merger, SPAC is replaced by the acquired company. Further, reorganization and rebranding are carried out, the stock ticker is also changed.

• There are several RTO models. A public company can buy a private business. A private business can acquire a public company. It is also possible to exchange assets, etc. It does not matter which model is used. Ultimately, the public company is replaced by a private business.

• Through an RTO, a private company has the opportunity to go public without an IPO. This saves time and money and makes it possible to restructure the business. However, there is a risk that capitalization will decrease after the merger.

Reverse takeovers are most often used by foreign companies to enter large capital markets, such as the US and the UK.