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I have written before in this space and in my recent book, SuperCash, about the rising popularity of reverse mergers. Reverse mergers are merger transactions that take place between a public company with little or no assets and a private company. The public “shell” then assumes the name and operations of the private company. Essentially, the reverse merger is an initial public offering for that private company.

Some of the more famous reverse mergers were Turner Broadcasting and Occidental Petroleum. In the 1990s, when there were three times as many investment banks and a ton of venture capital money being thrown at any company with no earnings or even revenues, reverse mergers took on a bad name for two reasons.

First, any company worth anything was doing an IPO the traditional way (through a mainstream bank). And second, the rubbish that was left was going public through the reverse merger process and then getting pumped and dumped by the unscrupulous.

The situation is different now, with many legitimate companies choosing to go public through a reverse merger rather than paying exorbitant fees to banks and lawyers for a traditional IPO.

Pacific Ethanol is a recent success story in the reverse merger world. The company merged into empty shell Accessity Corporation on March 24 2005. Right before the merger it completed a private financing – selling 7m shares at $3 a share. They did a Pipe (private investment in public equity) transaction in November 2005 with none other than Bill Gates, selling 5.25m units of convertible debt that could convert into shares at $16 a share and paid 5 per cent interest.

The stock now trades at $22.74 after completing a further $145m Pipe transaction, where it sold stock at $26.38 a share.

Another ethanol play that just went public via a reverse merger is Xethanol, which went public recently when it merged with bulletin board company Zen Pottery Equipment. This past week they began trading on the American Stock Exchange.

Other than Pacific Ethanol, the most newsworthy reverse merger in the past few years was when Bob Sillerman bought the rights to Elvis Presley’s media properties and merged them into the shell Sports Entertainment. The company now trades as CKX.

When that reverse merger happened a friend of mine was trying to buy the stock at about $1 (1,000 per cent higher than the day before) and I told him he was crazy. The stock then went past $20.

Since reverse mergers, almost by definition, are hardly followed by the research departments of the big investment banks, there are opportunities in finding these companies shortly after their merger and focusing on the ones with the best earnings or revenue growth prospects.

I recently met Steven Dresner, a partner at the Strategic Alliance Fund, a hedge fund focusing on (among other things) reverse mergers. His publication, the Reverse Merger Report, is a good resource. I asked him why there was such a sudden flurry of interest in reverse mergers. He said: “The certainty these alternative IPO transactions provide – in terms of not having to be concerned an underwritten offering will be pulled – has created a new primary market for securities of high-quality companies.”

Some of the recent ones I am looking at include Foldera, which makes web-based organisation software, web-based e-mail, instant messaging, and other collaboration software for companies. The private company merged with public company Expert Systems in February 2006, changing its name to Foldera and its symbol to FDRA. Expert Systems was a defunct golf products maker. Foldera, which is pre-revenue, traded as high as $9 a share after the reverse merger, down to $3.05 last Friday. That gave it a $300m market cap.

Another interesting web company to go public through the reverse merger process is Wall Street Direct, which completed a reverse merger in January 2006 with Financial Media Group. Wall Street Direct owns WallSt.net, which provides interviews with CEOs online. The company has a $46m market cap and since the reverse merger its shares have traded from 70 cents to $1.90.

Many private and profitable Chinese companies are also looking to go public in the US markets by merging into empty and clean shells. (“Clean” in this context means there are no pre-existing liabilities or shareholder lawsuits left over from the prior public entity). Zhongpin, a food processing company in China recently got “acquired” by empty shell Strong Technical which then changed its name to Zhongpin and changed its ticker to ZHNP. The company has five food processing plants in China. Sales were $73m in 2005, and the company is aiming for $110m in 2006.

Reverse mergers have been a successful way of breaking through the IPO oligopoly established by the first-tier banks. When the stats come out several years from now, my guess is that post-IPO results for reverse mergers will far surpass those of companies that went public through the traditional route

Copyright The Financial Times Limited 2017. All rights reserved.
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