The Securities and Exchange Commission

[thepennyking]

Reverse Mergers On the Rise?

By Avital Louria Hahn

So-called "reverse mergers," one of the more controversial ways for a private company to go public, are on the rise in the U.S., especially by Chinese and other international companies that often find even a depressed price for their shares in the U.S. to be far higher than anything they could fetch in their home markets.

"In the past six months or so we have seen an increase in companies looking to do a reverse merger," said Tim Halter, president of Halter Financial, a consulting firm that specializes in helping private companies go public. "We are seeing a lot of international deals, with many coming from Asia."

The evidence so far is anecdotal, as neither the American Stock Exchange nor Nasdaq keep track of reverse mergers. But Halter and others believe the controversial capital-raising practice is on the increase-and that is both good news and bad. Often termed the "back door" way to go public, it can be defined in various ways. Basically, however, it is a process in which a private company locates the shell of a public company, and enters into an agreement for the shell, which retains its ticker symbol, to purchase the private company with newly issued shares. The resulting company often changes its name-even its symbol-and sometimes uses its new stock to make acquisitions.

To be sure, quite legitimate firms have gone public this way. In 1970, Ted Turner used it to go public with Rice Broadcasting, which later became Turner Broadcasting Systems. In 1996, brokerage Muriel Siebert & Co. entered into such a back-door arrangement with J. Michaels Inc., a publicly traded Brooklyn-based retail furniture concern.

But the practice also has its share of critics, who maintain that the process is so porous it allows companies that never would have passed muster with an underwriter, let alone with investors on a roadshow, to wind up public.

Companies that do take this back-door route are often disappointed, according to Hartley Bernstein, president of Stockpatrol.com, a Web site that reports on penny stocks and small companies not covered by research analysts. With no analysts covering them and no banking relationships, they often find the public markets for additional financing closed, and the only capital they can raise is via private deals with onerous terms.

"[Buying a shell] sounds like a wonderful idea, except you don't get very much for it," Bernstein said. "It usually has no assets, and the stock is often controlled by investors who want to pump up the stock." Another negative, Bernstein added, is that the business that buys the shell can be tainted by the problems the former company had-or worse, inherit its liabilities.

What is more, reverse-merger companies frequently find the expense of being public too great. Expectations dashed, they then come to investment banks to undo the deal, said Rick Chance, managing director and head of restructuring at Calif.-based Trenwith Securities, which specializes in restructuring advice for middle-market companies. Chance said he has come across that very situation. On the other hand, Chance said, one of his clients is a Chinese company that became public via a reverse merger with a shell and is solid enough to make acquisitions.

A recent success
Despite the negatives, some companies this year are finding apparent success through the process. Consider China Automotive, which earlier this year decided to go public in the U.S., but found the initial public offering market closed tight.

China Automotive then found a law firm adviser that specialized in the process, and got hold of a public shell called Visions in Glass Inc. In May, it changed its name to China Automotive Systems Inc. and began trading on the OTC bulletin board under a new symbol. It closed last Thursday at $3.82 a share, with a market cap of about $80 million-small by U.S. standards, but larger than most other international entrants.

China Automative is only one of several Asian companies recently involved in reverse mergers, according to consultant Halter. He added that they want the U.S. listing to enable them to make acquisitions. They're hoping to benefit from a share price in the U.S. that, while depressed, often reflects double or triple the valuation they would get in their home market.

Often, foreign companies seeking the back-door route may well be larger and in better financial shape than their U.S. counterparts. Indeed, small U.S. companies that do reverse mergers often have compromised financing capability and end up paying dearly for additional financing from private investors, bankers said.

Valde Connections Inc., for example, which is in the business of "identifying profitable clinical day spa and salons for potential acquisitions," recently went public via a reverse merger with Jdlphotos.com. Afterwards, with its stock trading at about $0.20 and additional public capital unavailable, it sold 4.6 million of its shares in May to an offshore investor for $500,000-barely $0.11 per share.

A stricter filter
to determine which firms should be allowed to go public is exactly what is needed, said Halter. "You have to have realistic expectations and strong fundamentals, a projected market cap of $30 million or more, and you have to look at your traded peer group and see how is it valued," Halter said. "You have to compare your company's performance to peers and arrive at projected market value."

Companies that do qualify can reverse merge in one of two ways, Halter said. One is to merge with a shell that is currently reporting and listed in the pink sheets or the OTC bulletin board, a listing that costs about $300,000 to $400,000 and takes 30 to 60 days. The other is merging with a nonreporting shell, a longer, more complicated process-it can take four to five months and costs about $150,000. By comparison, the cost of an IPO can run into the seven digits.

After going public via a reverse merger, a company has to win the support of research analysts and develop relations with investors. Without an underwriter, it has to do so on its own. China Automotive will have research starting in September as well as an investor relations firm, Halter said.

http://www.halterfinancial.com/article10.html

Note: China Automotive

http://www.otcbb.com/asp/mp_quotes.asp?Sort=4&Quotes=CAAS&Board.x=23&Board.y=9

http://www.chinaautomotivesystems.com/index.asp