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Reverse-mergers: Going Public Fast:

http://www.bizjournals.com/denver/stories/2004/08/09/story7.html?t=printable

Firm rides reverse-merger wave

The Denver Business Journal - August 6, 2004by Tom LockeDenver Business Journal
One Greenwood Village company is trying to bring a new level of professionalism and follow-through to the arena of reverse mergers, which is being flooded with demand from Chinese companies.

"There is a slew of Chinese companies lined up trying to go public in the U.S.," said Tim Keating, founder and CEO of reverse merger turnkey company Keating Investments LLC. The number is "certainly in the high 100s," he said.

The price for shell companies has doubled in the last 12 months, largely because of demand from Chinese companies, but also because of a stronger equity market coupled with a weak market for small-company initial public offerings, Keating said.

He ought to know. Keating Investments recently took one Chinese company, SORL Auto Parts Inc. (OTC BB: ECVL), public through a reverse merger.

A "shell company" is a public company with no business operations. A "reverse merger" occurs when a private company that wants to be public merges into the shell, typically getting 90 percent to 95 percent ownership of the new company while shell shareholders get the rest.

The reverse merger can be quicker and less expensive than going public through an IPO.

But on the downside, it also can mean little exposure to the investment community. A company can get forgotten among more than 3,200 Over the Counter Bulletin Board (OTCBB) stocks and more than 4,000 stocks on the "pink sheets," an electronic quotation system, run by Pink Sheets LLC. The pink sheets don't have the listing requirement for up-to-date financial reporting required by the OTCBB.

Keating helps overcome the exposure problem with a turnkey package that includes raising money for the newly merged company as well as acting as a "market maker" to buy and sell the shares, and keep its trading within a range of stability.

Shell companies trading on the OTCBB now cost about $300,000 to $500,000 for a controlling share of 75 percent or more, and a pink-sheet shell might cost half of that, Keating said. A Keating affiliated company has an inventory of five OTCBB shell companies.

Chinese companies see the U.S. public market as attractive partly because going public in China is an "extremely arduous process," Keating said.

A Chinese IPO can take three years, faces limitations on numbers of IPOs in a year -- with preference given to state-owned enterprises -- and founders can't trade their shares.

A U.S. IPO looks comparatively attractive because it might take a year, have a higher price-to-earnings ratio, and add prestige with U.S. clients. The Chinese companies typically use a Sino-foreign joint venture law to go public through holding companies in places such as Hong Kong, the British Virgin Islands or the Cayman Islands.

"The bottom line is these companies find it preferable and attractive to go public in the U.S. relative to going public in China," Keating said.

Reverse merger pluses vs. IPO
Keating recommends IPOs for companies that can launch them, but many small companies can't. It's hard to find underwriters for small ones, and IPOs can be expensive and time-consuming, easily taking a year versus 60 to 90 days for a typical reverse merger. For Chinese companies, it's even tougher because of hurdles such as translating documents. So they're opting for reverse mergers.

Brian Mandell-Rice, an audit partner with Denver-based accounting firm Hein & Associates, said he's seeing more demand for shell companies than in 15 years. He, too, thinks Chinese demand is a big factor.

Hein has been shy about doing reverse-merger business because some middlemen seem mainly focused on generating fees for themselves rather than helping owners of the merging entities, Mandell-Rice said.

But since Keating offers a turnkey approach that includes raising capital and making a market in a stock, it's not just going to collect its fee and bow out, according to Mandell-Rice.

On the plus side, going public through a reverse merger can ease access to capital and enable a company to use shares as currency to make acquisitions, he said.

On the other hand, without a market maker, a company could end up in "no-man's land" after a reverse merger, so that its stock doesn't move even if it's performing well. Higher costs of regulatory compliance and increased scrutiny under Sarbanes-Oxley federal legislation also are negatives, he said.

Why not raise venture capital instead of going public? Because it would typically be more expensive, Keating said. That's because a Keating study shows a public company is valued at higher multiple of sales, cash flow or net income than a private company.

For instance, the study shows a public company valued at two times net sales versus 0.6 times for a private company. So a VC firm investing in a lower-valued private company will demand a higher percentage ownership for the same dollar amount invested than for a public company.

Plus, the Keating strategy is to get the company off the OTCBB and onto the American Stock Exchange or Nasdaq Small Cap Market within a year or so.

"We're going to become the conductor. We're going to choreograph this whole thing," Keating said.

SORL has a market cap of $80 million. It had $33 million in sales last year and expects $46 million this year. Keating and its Chinese partner charged it $400,000 in fees and also got 4.5 percent of the newly merged company. The money for the shell, Enchanted Village Inc., came from Keating Reverse Merger Fund LLC, which was formed to invest in shells and also in private companies planning to reverse merge into the shells.

The reverse-merger market is large and fragmented, with "multiple hundreds of reverse mergers each year," Keating said. But his firm stands out because it's a broker dealer regulated by the NASD and SEC, he said.

One reason Keating got into the reverse-merger business is his belief he could establish a reputable firm in an industry that was not so reputable.

After managing the European Equity Trading Department at Bear Stearns International Ltd. in London, Keating founded Keating Investments in 1997, initially concentrating on helping small companies find financing.

He became interested in reverse mergers by accident in 2000, when he was asked by a friend to become the director of a public company with patented technology that it couldn't commercialize. It eventually shut down, and Keating searched for a private company to merge with, only to be confronted with questionable wheeler-dealers.

He thought he could do better by bringing a certain level of professionalism and integrity to the arena. "We're really trying to institutionalize and clean up the reverse-merger business," he said.

In part that means being selective. Keating calculates his firm gets 100 inquiries a month, but will do only six to eight reverse mergers this year.

It looks for businesses with $10 million to $100 million in annual revenue, and they generally should be profitable. To raise money for its clients, Keating turns to hedge funds, PIPE (private investment in public equity) funds and individuals.

Despite its efforts, the general environment hasn't changed a lot. "I'd say it's still largely sleazy," Keating said.

For instance, there are the "pump-and-dumpers." They get stock for arranging a reverse merger, hype the stock and sell it into an inflated price. Then they quit hyping and the stock falls, sometimes below its true value. That hurts the merged company in raising funds, because a lower stock price means issuing more shares to raise the same amount of money.

Keating Investments gets recommended by lawyers and accountants to their clients because "they know this is a dangerous area," Keating said. "You can get taken advantage of and abused."

He likes to work with entrepreneurs, and Chinese entrepreneurs in particular are knocking on his door. "I think we're probably going to do three or four Chinese companies this year alone," he said.

Clients like NASD pros, clean shells
Dennis Depenbusch, CEO and chairman of Fort Worth, Texas-based Catalyst Lighting Group Inc. (OTC BB: CYSL), said he probably researched more than 100 firms before selecting Keating to help with its reverse merger.

He picked Keating partly because of the registration of its employees with the NASD and because of their experience. "Keating was the only one that has good, pedigreed professionals that have registered with the NASD," he said. "You really need to do your homework, because the reverse-merger world has a bad reputation."

Keating's references checked out, and Depenbusch also liked its turnkey approach. "I have not run across a shop of integrated professionals like Keating. He's unique in that way," Depenbusch said.

Catalyst Lighting, which provides lighting support structures, needed $2 million to $3 million in financing, and opted for a reverse merger because it costs less than an IPO.

The 23-employee firm, which has about $20 million in annual revenue, raised part of what it needed, about $500,000, in a follow-on offering. The entire process is not an easy one, he said, but Keating has stuck with Catalyst "the entire way."

With Catalyst, Keating created a shell called a "blank check company" through SEC Rule 419. But Keating said that route is extremely complex and too time-consuming, and he now prefers to buy existing shells.

Catalyst hopes to relocate to the American Stock Exchange or the Nasdaq Small Cap Market within 24 months, Depenbusch said.

Raymond Zimmerman, chairman and CEO of Boca Raton, Fla.-based retailer 99 Cent Stuff Inc. (OTC BB: NNCT), said he chose Keating partly because it had the cleanest shell company. His company had a reverse merger with iVideoNow Inc. in September and that month filed a registration statement for a $3.8 million stock offering the SEC approved in February. The SEC approval took longer than he anticipated, Zimmerman said.

The reverse merger was smoother and faster than an IPO would have been, Zimmerman said. He hopes the company, which had $40 million in sales last year and employs 500 people, will be able to qualify for the Nasdaq Small Cap Market next year.

"Reverse mergers today are very much accepted," Zimmerman said. "It's so much easier to do. There's a lot of them being done."

He said he is "absolutely" happy with the job Keating did. "There was never a harsh word," Zimmerman said. "They're probably the most honorable of all the people I've ever dealt with."