Backdoor warning for small investors

Usually the stock exchange cycle moves in predictable ways, it’s just getting the timing right that presents investors with a challenge.

As I’ve said before for most of this year the Australian market has been trying to break out from the 5500 – 5600 range and its finding it difficult. Therefore this year’s earning season just underway will hold the key to whether the market can move higher, albeit as long as there are no external shocks.

Industrial leaders look to be fully priced while the mining/resources sector is struggling under commodity price pressure as more supply comes online around the world, Investors have taken to seeking new opportunities in the initial public offering market which has seen more than 100 new floats coming to market and it wont be long before we see investor fatigue in this area if the IPO pipeline doesn’t slow down.

The latest cycle we are witnessing, particularly in Perth, is the re-emergence of a backdoor listing market. Many small WA mining explorers have been struggling and their share prices bumping along at rock bottom levels. Their distress has attracted new start-ups, particularly from the technology sector, which would like to list, but are themselves financially challenged.

Backdooring through a shell company is not only attractive to the start-ups because it negates a lot of the IPO costs, but it offers some hope to those stranded investors in the listed vehicles who believe they finally may see ‘some’ return on their investment.

But what they and other new investors are doing is swapping one speculative venture for another. If they’re happy with that view that’s fine but investors climbing onboard the tech start-up bandwagon should be warned that a backdoor listing also carries more risk than a normal front door IPO because investors aren’t privy to the same sort of information they would normally receive.

They’re just going along for the ride and they shouldn’t be too surprised if the new entity uses its new listing status to put through a capital-raising issue soon after gaining control.

This has led the Australian Securities & Investments Commission this week to warn investors of the heightened risks of investing in such companies.

Quoted in the Australian Financial Review, ASIC commissioner John Price said the trend is raising a number of regulatory issues similar to those seen during the “dotcom boom” in the early 2000s. “This is an emerging trend and we have seen specific problems with this trend before so it is really just about calling it out early,” Price told a media briefing in Perth.

ASIC’s Perth office has taken action on a quarter of the 12 recent “mining to tech” backdoor listings, adding that a further six such listings have been announced and there are at least another 20 companies, predominantly within mining exploration, that are considering the change in tack.

ASIC commissioner Cathie Armour said shareholders need to ensure they are getting full disclosure from the incoming company. “The concern we have is that shareholders might not be getting the information they need,” Ms Armour said. “We just really want shareholders to be completely informed about what’s going on. Understand how the company is changing its business plan and really be alive to the risks of the new business.”

As an example of what’s going on in Perth later that same week Perth-based IT systems consultancy Cirrus Networks commented on its plans to go public through a reverse takeover of a flailing junior mining company. Cirrus Networks co-founder and chief executive Frank Richmond told the AFR  that his company is pursuing negotiations with a shortlist of three junior Perth-based mining companies that are all looking for an exit strategy in a tough market.

“We have looked at a number of paths to market but a backdoor listing seems to be the easiest route,” Richmond said. “There are lots of stagnant shell companies in Perth with shareholders that are eager to see the directors do something more for them.”

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