FIRMS in China looking to jump a massive queue of firms seeking to do initial public offerings (IPOs) and start trading their shares on the Shanghai or Shenzhen markets are increasingly going through the backdoor by taking control of firms that already have coveted listing status.

    The fashion for reverse takeovers is seeing some unlikely combinations, such as a mobile game developer getting listed through a shoe company and a pharmaceutical distributor tying up with a brewer. In such deals, a listed firm buys a bigger privately-held firm through a share exchange that gives the private firm’s shareholders control of the merged entity.

    Firms in the IPO queue and those advising them had hoped China would shift to a faster registration-based system for stock market flotations from the current approval regime this March. But the new securities regulator said it would take time to draft the new rules, leaving 762 firms lined up seeking to do IPOs and many of them concerned that the process could take years.

    This is prompting firms to consider acquiring listed entities whose businesses are often very modest or deteriorating in a bid to gain quick market access.

    “It’s a sign of firms’ complete lack of confidence in their ability to calculate how long they would have to wait to get a primary IPO listing in China. It’s absolutely unknowable at this stage,” said Peter Fuhrman, CEO of China-focused investment bank China First Capital.

    These deals are proving lucrative for investors in the firms being acquired — often at sizable premiums to their stock market value — but they also raise governance concerns as those getting backdoor listings do not get the same scrutiny they would face in a formal IPO.

    Reverse takeovers also bring back memories of a series of accounting scandals in 2011-2012 involving Chinese firms that gained access to U.S. markets through those transactions. The U.S. Securities and Exchange Commission (SEC) suspended trading and revoked the registration of some firms, with more than 100 of them delisted or suspended from trading on the New York Stock Exchange (NYSE) over the two-year period because of fraud and accounting issues, according to a McKinsey & Co. report.

    In a public bulletin in June 2011, the SEC warned investors that “many firms either fail or struggle to remain viable following a reverse merger” and noted there had been “instances of fraud and other abuses involving reverse merger firms.” The regulator later approved tougher standards for reverse mergers on both the NYSE and NASDAQ exchanges.

    Some other markets, including Hong Kong and Australia, also tightened and clarified rules on backdoor listings to prevent similar problems.

    “The main concern with backdoor listings is...that they are often easier than IPOs and firms do not have to go through the IPO application process and accompanying scrutiny,” said Jamie Allen, secretary general of the Asian Corporate Governance Association.

    An average of 10 firms a month were granted approval to list on the two Chinese exchanges this year and at that rate the backlog will take nearly six-and-a-half years to clear.

    Firms have carried out US$20.6 billion worth of reverse mergers so far this year, including a US$2.7 billion deal by Alibaba-backed logistics firm YTO Express in late March to merge with a Shanghai-listed clothing maker.

    That’s higher than the US$19 billion in deals over the same period last year and comes after a record US$66.9 billion in backdoor listing activity in all of 2015, which was also spurred by a temporary shutdown of the IPO market in China. By comparison, volumes were US$46.5 billion in 2014 and US$27.4 billion in 2013. (SD-Agencies)