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Reverse takeovers: No longer the poor man's IPO

Reverse takeovers hold their own against IPOs as a route to public market, 18-year study shows

Reverse takeovers (RTOs) have long been maligned as a poor man's initial public offering (IPO) but dealmakers who write them off could be missing a valuable route to the UK public market, research suggests.

A new 18-year study has revealed RTOs are more resilient in the teeth of a recession, share similar survival rates to IPOs and in some cases go on to outperform their counterparts.

The findings by the M&A Research Centre at Cass Business School, part of City University London, followed the analysis of more than 240 RTOs and 1600 IPOs listed in the UK between 1995 and 2012.

The authors found that, while the number of IPOs fell during a market correction, RTO volumes showed resilience.

"When the dotcom bubble burst at the start of the Millennium, IPOs dropped from 201 in 2000, to 78 in 2001 and 54 in 2002. By contrast, although still relatively few, the 13 RTOs in 2000 and 2001 grew to 17 in 2002," said Professor Scott Moeller, Director of Cass's M&A Research Centre.

"The gap also narrowed during the more recent financial crisis where IPOs dropped by 98 per cent between 2006 and 2009, compared to an 80 per cent decline in RTOs.

"These results suggest that RTOs can offer a viable route to public listing during adverse market conditions when the IPO window can all but close."

Reverse takeovers - which occur when a private company takes over a publicly traded one - are acknowledged as a cheaper and faster route for companies to list on a public exchange.

However, they have attracted adverse publicity fuelled in part by a wave of Chinese reverse mergers, along with US studies showing poor survival rates and underperformance compared to IPOs.

Cass researchers, however, discovered similar survival rates for RTOs and IPOs in the UK.

In the second year of listing, 90 per cent of RTOs survived compared to 95 per cent of IPOs. This compares to the US where just 46 per cent of reverse mergers (as they are generally classified) survive the first two years against 93 per cent of IPOs.

According to the study, the success of RTOs depends on the type of publicly-listed company dealmakers choose to reverse into.

Companies can reverse into an active public company for synergy gains; through a special purpose acquisition company (SPAC); or via a mature cash shell, which is often bankrupt.

The Cass study found that RTOs targeting synergy gains have a significantly higher survival rate than SPACS and mature shells.

The authors went on to compare the aftermarket performance of RTOs and IPOs using a buy-and-hold strategy.

They discovered that RTOs underperform relevant benchmarks by 28 per cent over three years, while IPOs beat the market by 11 per cent. However, the underperformance of RTOs as a group appeared to be the result of a relatively small number of large SPAC RTOs.

Intriguingly, the study revealed that smaller RTOs outperformed their larger peers, in contrast to IPOs. Again, those pursed for synergy gains performed better than SPACs and mature cash shells.

"For smaller companies, there may be a number of advantages to pursuing an RTO, such as the lower cost of listing as well as the fact that the RTO target is likely have existing analyst coverage - something many smaller companies often struggle to achieve when taking the more conventional IPO route," Professor Moeller said.

He added: "Our findings may come as a surprise to some dealmakers who write off RTOs.

The results indicate RTOs can hold their own against their more favoured IPO cousins and can allow smaller companies to pack a punch when listing on the public markets."

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