Will Moncrieff and Jamie Ogilvie of Perth-based law firm Jackson McDonald consider how 'backdoor listing' may provide an opportunity for companies struggling in a tough resources market to reinvent themselves and examine the regulatory landscape.
The Australian resources sectors, as well as businesses providing goods and services to the sector, have seen a significant downturn in investment activity and profitability over the past four years. This is due to the perfect storm of a slowdown in the growth of the Chinese economy, major falls in commodity prices (particularly iron ore and coal), a transition from the construction phase to the production phase in major iron ore and oil and gas projects, and a persistently strong Australian dollar.
Some indicators of the headwinds battering the sector include:
A 72 per cent fall in the iron ore price, from US$187 per tonne (in February 2011) to US$52 (in October 2015).
A 60 per cent fall in the thermal coal price, from US$142 per tonne (in January 2011) to US$56 (in October 2015).
A 54 per cent fall in the Commodity Metals Price Index, from 256 (in February 2011) to 118 (in October 2015).
A 62 per cent fall in the S&P/ASX 300 Metals & Mining Index, from 5,491 (in April 2011) to 2,087 (in November 2015).
Coupled with this brutal downturn in the macro-economic environment has been a consequential fall in new investment in mining exploration and development activity. This trend has been felt particularly strongly in the junior end of the market, where new equity capital for exploration and development activities has become increasingly difficult to access, whether by way of initial public offering (IPO) or other capital raising mechanisms.
This trend is highlighted by the expenditure data for minerals exploration (other than petroleum) in Australia, which has fallen 60 per cent over the past four years from a peak of almost A$4 billion in FY11 to A$1.575 billion in FY15, showing no signs of reversal in the near future.
Innovation and entrepreneurial spirit leading to corporate re-invention
The lack of access to fresh equity capital has seen most junior explorers significantly curtailing their exploration programs and in many cases limiting activities to those required to meet minimum expenditure obligations. Others have bitten the bullet and, deciding that the likely timing of a recovery in the resources sector is beyond their commitment horizon, have looked to greener pastures and particularly to opportunities in emerging technologies.
The change of focus for these companies has been activated principally by way of ‘backdoor listing’ privately-held entities into the listed shell, with the vendors of the private entity receiving equity in the shell as consideration as well as board and, in many cases, voting control.
The capacity for corporate reinvention in the face of existential threats has been a feature of Australia’s listed company landscape (particularly in Western Australia, the state with by far the largest number of small cap explorers). This has been previously shown in the not too distant past when, following the dotcom bubble and crash in 2000, many nascent technology companies disappeared into oblivion, effectively as shells, only to re-emerge, courtesy of a backdoor listing, as explorers.
Beginning in 2014 and in response to increasingly challenging market conditions, many explorers have adopted a similar strategy; though this time the explorers are turning to emerging technology businesses. Over the past two years, more than 50 technology businesses have ‘listed’ on the Australian Securities Exchange (ASX) through being acquired by small cap listed companies, the majority of which have been junior explorers based in Western Australia.
There are a number of reasons for this phenomenon, which is in many ways unique in the context of global equity market activity. They include the:
Spirit of entrepreneurship and innovation common in remote communities (notwithstanding the paradigm shift in global connectedness occasioned by the development of the internet, Perth remains a long way from anywhere).
Regulatory regime which, while not exactly encouraging, permits the backdoor listing process to accommodate businesses which may not be ‘IPO ready’. Or, in the case of North American entities, those which do not qualify for listing on US exchanges (such as NASDAQ) and cannot access the deep US private equity market.
Existence of an investment community comfortable with the risks associated with speculative ventures (a common feature of both mineral exploration and technology development) and professional advisers supporting that community.
Continuing strong growth in the non-resources sectors of the WA economy, with Gross State Product forecast to grow by 2.25 per cent in FY16, 3.75 per cent in FY17 and 5.0 per cent in FY18.
A recent example has been ASX-listed Magnolia Resources Limited (now known as Kabuni Limited – ASX: KBU) which, by way of the backdoor listing of Vancouver-based Kabuni Technologies Inc., has been transformed from a junior explorer. With exploration interests in a Western Australia technology business driving the development of ‘Kabuni’ (a North America focused Software-as-a-Service (SaaS) platform connecting interior designers with homeowners), they have been able to create a true omni-channel retail experience. The platform enables homeowners to consult with home design experts for free and purchase quality home products and services online.
The backdoor listing was preceded by a convertible note raising (in Kabuni Technologies, with the notes convertible into Magnolia shares conditional on completion of the acquisition). This is a common approach designed to provide interim funding for the private entity without financially committing the listed entity to the deal before obtaining shareholder approval. This was followed by a capital raising in the listed entity (by way of prospectus), a meeting of shareholders to approve the transaction and the capital raising, and compliance with ASX’s admission and quotation requirements.
Businesses looking to take advantage need to be well-advised
While backdoor listings have been a feature of the Australian equities market for many years and the process is well understood, potential candidates need to ensure that they can meet the expectations of a regulatory regime that is becoming increasingly rigorous. Careful coordination of the various elements of these transactions is also essential.
The ASX, in its capacity as the key market operator and regulator, and the Australian Securities & Investments Commission (ASIC), the corporate regulator, have been closely scrutinising backdoor listing activity since it began to flourish in 2014. This regulatory scrutiny is facilitated by some of the key features common to most backdoor listings, which include the:
Requirement under the listing rules of ASX for shareholder approval for the change in the nature of the activities of the company.
Requirement that, following shareholder approval for a change of activities, the company re-comply with ASX’s admission and quotation protocols.
Lodging of a prospectus with ASIC to recapitalise the shell.
ASIC and ASX collectively have both governance and commercial objectives to ensure the quality of new entrants to the listed space. They are working cooperatively by paying close attention to disclosure documentation prepared for obtaining shareholder approval and recapitalising the listed shell. ASIC in particular is closely examining prospectuses lodged with it and is quick to issue stop orders if it considers that disclosure is inadequate. Particular areas of focus by ASIC include the:
Financial and operating history of the incoming business – ASIC is insisting on audited accounts for the past three years, notwithstanding that that the private entity may not otherwise have been obliged to prepare audited accounts.
Provision of detailed information about the valuation of the business and, in particular, intangible assets.
Legitimacy of the proposed business model, which must be described in detail and with the associated risks prominently displayed.
Roles and antecedents of the incoming directors and managers.
We have observed that inadequate planning and documentation and a failure to proactively address the known concerns of the regulators can significantly delay, and in some cases completely derail, completion of the transaction.
Companies undertaking these transactions should ensure that they are properly advised regarding the regulatory landscape. This is particularly important when the transaction has cross-border elements, where multi-jurisdictional compliance with regulatory requirements may become an issue.
Will Moncrieff is a partner and Jamie Ogilvie a senior consultant at Perth-based law firm Jackson McDonald, a member of the Globalaw network.
 Resources sector IPOs have fallen from 32 (out of total IPOs of 71) in FY13 to 5 (out of total IPOs of 95) in FY15.
 Australian Bureau of Statistics: 8412.0 Mineral and Petroleum Exploration, Australia, June 2015.