Formerly shady reverse mergers gain credibility

By Matt Krantz, USA TODAY

Blackstone Group and Fortress Investment Group stole investors' attention with their splashy initial public offerings. On Monday, another alternative investment company revealed it plans to go public by using a method formerly thought of as being for fly-by-night companies.

GLG Partners, a hedge fund that claims $20 billion in assets under management, said it will perform a reverse merger with a publicly traded shell company called Freedom Acquisition. The deal would instantly turn GLG into a publicly traded company worth more than $3 billion. To complete the deal, GLG will change Freedom's name to GLG Partners and its stock symbol from FRH to GLG.

Reverse mergers are transactions in which a private company combines with a publicly traded shell company that has no operations. That gives the private company the respectability and currency of being a public company without having to meet the regulatory requirements for an IPO. A common knock against reverse mergers is that they have been abused by fraudsters to get stock that they can sell to naive investors.

The GLG deal, though, uses a 3-year-old type of reverse merger called a special-purpose acquisition company, nicknamed a SPAC or blank-check company.

A SPAC is formed in two steps. First, the shell company sells shares to the public as an IPO. The shell, which usually trades on the American Stock Exchange or lightly regulated OTC Bulletin Board market, has a management team that promises to use the IPO proceeds to find a promising (and usually private) company to merge with. An existing business, GLG in this case, then folds into the SPAC.

FIND MORE STORIES IN: David Feldman | GLG | SPAC
Some well-known business people, including Apple co-founder Steve Wozniak, have been involved with SPACs. This year, 33 SPACs have raised $4.1 billion, vs. the $1.8 billion raised from 25 SPACs in the same time frame last year, says Dealogic. In 2004, at the dawn of SPACs, there were just 13 that raised $484 million. Freedom was formed in December after raising $528 million, making it the largest SPAC ever formed.

SPACs offer investors safeguards by letting them vote on the merger and protecting their money in an escrow account until a deal is signed, says David Feldman, partner at Feldman Weinstein & Smith, which advises companies on reverse mergers.

SPACs have lent more credibility to reverse mergers, which still have their fair share of deals "that are a little shady," says Meghan Leerskov, associate editor of The Reverse Merger Report. This year, there have been 90 traditional reverse mergers between private companies and public shells with no operations, she says, vs. 212 last year.

While SPACs may be more legit than many traditional reverse mergers, Jay Ritter, professor of finance at the University of Florida, cautions investors. He views the rash of SPACs to be a reaction to the popularity of private-equity funds and a way to make individual investors feel like they're getting a piece of the buyout action. "I view this as a fad," he says. "I'm certain the crash-and-burn will happen at some point."

http://www.usatoday.com/money/companies/2007-06-25-reverse-mergers-usat_N.htm

NYSE Proposes Listing Standards Enabling Acquisition Companies To List On Exchange

New Opportunities To Benefit Issuers and Investors in Fast-Growing Segment
NEW YORK , March 6, 2008 – NYSE Euronext (NYX) today proposed rule changes to allow the listing of Acquisition Companies (ACs) on the New York Stock Exchange (NYSE). The proposal, filed with and subject to approval by the U.S. Securities and Exchange Commission, will allow ACs – companies set up to raise IPO capital for subsequent acquisitions or mergers - to list on the NYSE for the first time.

"Acquisition Companies provide opportunities for investors and issuers previously available to professional investors only,” said Noreen M. Culhane, EVP, Global Corporate Client Group, NYSE Euronext. “After careful marketplace analysis over an extended period of time, we decided that recent changes in sponsorship, scale and deal structure warranted the listing of ACs on the NYSE.”

NYSE Euronext, on its European markets, has already enjoyed considerable success with listing special purpose acquisition companies. On Feb. 6, Liberty International Acquisition Company, a special purpose acquisition company (SPAC) successfully listed on NYSE Euronext's Amsterdam market, raising a total of EUR 600 mln ($877.6 million) in new capital. Liberty International Acquisition Company was the second special purpose acquisition company (SPAC) listing on NYSE Euronext’s Amsterdam market, after the successful listing of PEHAC in 2007.

The NYSE currently does not have a financial listing standard that would allow an AC conducting an IPO to list on its market. The rule will impose Acquisition Companies to have at least $250 million in total market capitalization and $200 million in public float at the time of initial listing. The rule will impose investor protection and structural safeguards on Acquisition Companies, such as the requirement that a minimum of 90% of the IPO proceeds be placed in trust and a requirement that a business combination be undertaken within three years based upon a favorable vote of a majority of the publicly-held shares, subject to a right of dissenting shareholders to request redemption.

http://www.nyse.com/press/1204801796472.html

NEW YORK, May 07, 2008 (BUSINESS WIRE) -- Sales of alternative investment firms account for a record 40% of deals in the global investment management business thus far in 2008, according to Jefferies Putnam Lovell, a leading adviser on alternative investment transactions and the division of Jefferies Group, Inc. (JEF:JEF 18.87, -1.49, -7.3%) focused on the asset management and financial technology industries.

Through April 2008, 29 of the 73 transactions announced involve alternative investment firms, according to New York-based Jefferies Putnam Lovell. The total includes 20 transactions of hedge fund and fund of hedge fund (FoHF) managers. Deal flow in 2007 involving alternative investment firms represented 32% of the 241 total transactions in the global asset management industry.

''We expect record demand for alternative asset managers to continue throughout 2008, motivated by buyers' search for absolute returns and innovative products in challenging capital markets,'' said Aaron H. Dorr, a New York-based Managing Director at Jefferies Putnam Lovell.

Jefferies Putnam Lovell has been involved as financial adviser in several of this year's most significant transactions involving firms in the alternatives sector, including:

-- This week's announced sale of an interest in Stamford, CT-based Aladdin Capital Management, which focuses on non-traditional fixed income strategies, to Japan's Mitsubishi Corp.

-- The announced reverse merger between global multi-strategy investment firm Halcyon Asset Management and Alternative Asset Management Acquisition Corp., a publicly traded SPAC (AMV:March 2008.

-- The sale of an interest in Hong Kong-based alternative investment specialist Vision Investment Management to Turin-based investment company IFIL. February 2008.

-- The sale of Carlsbad, CA-based hedge fund administrator HedgeWorks to Deutsche Bank. January 2008.

http://www.marketwatch.com/news/story/story.aspx?guid=FECA5C0F4CCE46BA9279571DCD1E37CA&siteid=nbk

FOCUS: Dealmaking
Reverse mergers are hotter than Szechuan
Backing into a shell is a faster, cheaper way to go public in the U.S. than a traditional IPO. Chinese companies especially love it.

By Tim Catts
July 14, 2008

Joseph Meuse, the managing member of Belmont Partners in Washington, Va., describes his firm as “the CarMax of shell corporations.” In other words, he runs a giant depot of what are essentially the ghost ships of business: public companies that no longer have any operations of their own, or maybe never did, but remained current in their Securities and Exchange Commission filings and now sit idle, ready to provide a relatively quick and inexpensive route to U.S. capital markets for privately held enterprises that don't want to, or can't, carry out a traditional initial public offering.

Mr. Meuse and his company are part of a small but thriving ecosystem of investment bankers, attorneys and shell corporation brokers who see great opportunity in transactions called reverse mergers, reverse takeovers or “alternative public offerings.” In these deals, a private company merges with a public one solely to take advantage of the public entity's listing on a U.S. exchange.

From Chinese medical equipment manufacturers to fledgling U.S. biotech firms, companies looking to raise relatively small amounts of capital have turned away from traditional IPOs to this alternative path to the market. They are going public in reverse mergers and often raising capital from institutional investors when the deal closes. In many ways, the deals are mirror images of those involving special purpose acquisition companies, or SPACs, in which a publicly traded shell corporation is set up by investors to acquire privately held companies and bring them to market.

According to data compiled by the Reverse Merger Report, a trade publication that covers the field, 94 companies went public in these deals in the first half of this year, compared with 100 over the same period last year and 99 in the first six months of 2006. But the share of these deals involving obscure Chinese companies has exploded, from 19% two years ago to 32% so far this year.

“The rate of growth in these transactions is really high,” said Maj Soueidan, president of Market's Edge, an investment firm that tracks the deals and invests in Chinese companies that have participated in them.

And with only 22 companies floating IPOs in the first quarter of 2008, compared with 53 in the same period last year, this could be the rare year that reverse mergers are the more popular route to going public, said David Feldman, a founding partner of Feldman Weinstein & Smith, a New York law firm specializing in the deals. “Even if you're looking for $200 million or $300 million, there are no IPOs for anyone right now.”

Meanwhile, companies pursuing reverse mergers are typically looking for less money. Indeed, all companies raising capital via private placement concurrent with a reverse merger attracted a total of $187 million so far this year, according to figures from the Reverse Merger Report. “Many people are referring to this as the heyday of reverse merger transactions,” Mr. Feldman said.

Reverse mergers have taken off, while traditional IPOs have slowed significantly due to the turmoil in the credit markets. Much more stringent SEC disclosure requirements and an influx of Chinese companies looking to reverse mergers as a faster route to U.S. capital markets have also contributed to the surge in the number and value of deals. Recently, bigger and more profitable Chinese companies have undertaken reverse mergers, further helping the deals shake off an unsavory past as the province of boiler-room scams and pump-and-dump artists.

“It's the quality and the size of the companies going public through the reverse takeover method that's helped legitimize it,” said Matthew Hayden of HC International, a San Diego company that handles investor relations for some 30 Chinese companies that have gone public here via reverse merger.

The basic reverse merger works like this: A privately held company will spend anywhere from a few hundred thousand dollars to a few million dollars to buy the lion's share of stock in a publicly traded “shell” company, so called because it no longer has any real business of its own but has stayed current with its SEC filings in order to keep its shares listed. Shell companies typically trade over the counter via the OTC Bulletin Board quotation system. Some boutique investment companies and advisory firms specializing in reverse mergers keep a stable of shells available for sale and try to clean up some of their problems, which can include liens, court judgments and disgruntled shareholders. Others take steps to create “virgin” shells that offer a blank slate.

This process alone does not introduce any new capital into the company. To address that situation, many companies bring in institutional investors through private placements as soon as the reverse merger closes. The average value of an IPO last year was $229 million, according to data compiled by Renaissance Capital. In contrast, it isn't uncommon for companies going public in a reverse merger to raise $10 million or less.

Chinese companies are increasingly taking advantage of reverse mergers because they're relatively quick and inexpensive. “It's not that they're enthralled with the U.S. markets,” Mr. Hayden said. “They want access to growth capital, and this is the avenue that works.” Recent typical examples of Chinese companies using a backdoor into the U.S. capital markets include Shanghai Medical Technology, which merged into Aamaxan Transport Group in May and raised $12.5 million in a concurrent PIPE, and Yongye Biotechnology International, which raised $10 million through a PIPE concurrent with its merger with Golden Tan in April.

At least half of Chinese companies going public through reverse mergers have at least one manager who speaks English, and nearly all participate in some kind of “road show” to familiarize U.S. PIPE (private investments in public equity) investors with their businesses, Mr. Hayden said.

Chinese officials plan to open a Nasdaq-style exchange for small companies and start-ups in the near future, but “our belief is that listing in the U.S. will still be favored by many companies for at least the next two years,” Mr. Hayden wrote in a note to clients in April.

Chinese firms may be the hottest part of the reverse-merger market, but that's not to say U.S. companies aren't using the deals as well. A number of small biotech firms have used reverse mergers paired with private placements to access the capital they need to fund trials of experimental drugs instead of partnering with, or selling themselves to, big pharmaceutical companies, said attorney John Paris of Richmond, Va.-based law firm Williams Mullen.

Nonetheless, many of the boutique investment banks, investor relations shops and law firms springing up to help companies with these transactions focus on far-flung regions of the world. Certainly, China is immensely popular. But other firms, such as Southern Trust Securities, a Miami-based investment bank, specialize in areas such as South America and the Caribbean. Kevin Fitzgerald, the firm's president, said Southern Trust has helped companies from Argentina and Mexico as well as China undertake reverse mergers in the past 15 months, and has deals pending with companies from Spain, Iceland and South Korea.

“You have some really profitable businesses overseas that really can't go public without these kinds of transactions,” Mr. Fitzgerald said, because they're too small for a traditional IPO in the U.S. or are blocked from accessing capital markets in their home countries.

Reverse mergers have begun to shake off a reputation for being the province of boiler-room operators in the three years since the SEC changed the rule governing financial disclosure for companies that go public in those deals. Pump-and-dump scammers long exploited the lack of transparency in reverse-merger transactions to bring questionable companies into the capital markets, inflate their stock prices through high-pressure sales tactics, and then sell their stakes, leaving unsuspecting investors with massive losses.

In 2005, the SEC amended the laws governing the sale of shares in companies that have undergone reverse mergers to require more disclosure of financial information. That hasn't stopped reverse-merger scams, but it has made it easier to identify legitimate companies. The requirements are now comparable to those faced by companies going public through a traditional IPO, according to Mr. Paris. “You'd have the obligation that Google had,” he said. Mr. Feldman agreed: “It's an industry that's shaken its semi-shady past very effectively.”

The rising popularity of PIPEs among institutional investors has also made reverse mergers a more attractive option for small companies. In particular, hedge funds are eagerly providing capital in private placements with companies using reverse mergers to go public, observers said. The SEC requires these investors to hold their shares for up to a year before selling them, but that period can vary.

Most deals also include “make good” provisions, which require company managers to place a portion of their stock in escrow and set net income targets that, if missed, give investors the right to claim the shares. That gives an added element of security to institutional investors providing capital to companies going public through reverse mergers, Mr. Hayden said.

In practice, Mr. Feldman said, most institutional investors realize private placements with companies involved in reverse mergers require some patience. “Most PIPE investors know they're looking at one to two years before they see any liquidity,” he said.

Hedge funds aren't the only big players investing in reverse-merger companies. Lawyers and bankers specializing in the practice say some Wall Street heavy hitters are happy to fund them as well. “They're starting to see the upside,” Mr. Meuse said.

Mr. Meuse has big plans for Belmont Partners. “Like any new young market, you have a lot of people in this space, and no one has a huge share,” he said. Working with Chinese companies—and companies in other fast-growing emerging markets, such as Brazil—is the way forward, he said. “On a macro level, we want to be an Asian investment bank with American owners and an American presence.”

While some players like Mr. Meuse see immense opportunity ahead in the reverse-merger business, others, like Mr. Keating, believe the market may have already passed its peak.

In fact, the amount of capital raised in private placements accompanying reverse merger transactions through June has fallen 60%, from $469 million in the first six months of last year, according to the Reverse Merger Report. To support his contention, Mr. Keating cites SEC rules changes enacted in February that require investors in companies that have gone public through reverse mergers to hold their shares longer than those who've put their money in companies that haven't. That puts investors in reverse-merger PIPEs at an unfair disadvantage, Mr. Keating said.

Other rule changes may also keep investors away from the deals, including one that blocks some investors from selling shares in a reverse-merger company if it -doesn't stay current in its SEC filings and another that loosens the protocols governing the formation of shell corporations, opening the door for scammers to market flawed shells as pristine. That's not to say all recent regulatory developments have been negative: The same round of rule changes created liquidity in other ways—for example, by eliminating volume restrictions for investors looking to sell their shares, Mr. Feldman said.

Ask Mr. Keating if this is the heyday of reverse mergers, and he says it has already passed. “I would have said yes, it was, until very recently,” he said. He is guiding clients toward another IPO-less route to public trading that doesn't involve shell corporations: “Self-filing” instead requires the company to file with the SEC to resell stock held by existing shareholders and voluntarily assume the responsibilities of reporting financial results.

Mr. Meuse, meanwhile, is encouraged by the arrival of bigger institutional investors—including funds run by Wall Street heavyweights—seeking to invest in reverse-merger companies. “Is it still growing? Absolutely,” he said. “It has the look and feel of a market that's going to stay strong for a while.

http://www.financialweek.com/apps/pbcs.dll/article?AID=/20080714/REG/627375125