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Tanduay Holdings Inc., whose shares publicly trade under the stock symbol “TDY,” last week became the darling of the local stock market, surging 187 percent in three days to P14.66 before ending the week at P10.88. It opened stronger this week a little below P12.
The surge in its share price came in the wake of the company’s announcement of a reverse merger or reverse takeover by Lucio Tan, the country’s second richest taipan, through his holding company, Tangent Holdings Corp. In exchange for five billion shares of Tanduay at the par value of P1 per share, the wily taipan’s holding company would transfer its ownership of a number of companies.
Tanduay’s board of directors, also controlled by Tan, agreed to acquire the shareholdings of Tangent in the following companies: - 90 percent ownership interest in Asia Brewery, the second largest beer maker in the country;
- 83 percent interest in cigarette manufacturer Fortune Tobacco Corp.;
- 98.1 percent interest in mixed-use real estate developer Eton Properties Phils.;
- 49.84 percent interest in Philippine Airlines, one of the country's two flag carriers;
- 50.97 percent interest in Air Philippines Corp., the low-cost carrier subsidiary of PAL; and
- 34.79 percent in Philippine National Bank and 27.62 percent interest in Allied Bank, the country’s fifth and 13th largest banks in terms of total resources and now merging.
In case the reader has not been paying close attention, all those seven companies have a market value of more than P73 billion, at the recent market peak of P14.66 per share. Using the same measure, the Tan family’s shareholdings in Tanduay would be worth a whopping P123.5 billion.
That’s not the end of it. Equity analysts were quick to value the post-reverse-merger price of Tanduay at between P16 and P18.41. At the top end of that range, the companies to be infused into Tanduay would be valued at P92 billion at least.
Are those companies worth that much, in addition to the original value of the rhum business of Tanduay, which was placed by the market at P20 billion prior to the announcement of the reverse merger? It would all depend on their growth prospects, which at first blush don’t appear to be that rosy since they are all in mature industries. In the case of the beer, liquor and cigarette businesses there is the further threat of higher sin taxes next year which, when taken together with the declining sales due to recent trends towards healthier lifestyles, would mean that a portion of those sin taxes may have to be absorbed by the companies.
Let’s leave the question of valuation. The main focus of this comment is on the art of the reverse merger: why a company, or taipan such as Tan, would resort to this sort of capital-raising exercise, and what are its advantages and disadvantages.
For starters, a reverse merger occurs when a private company takes over a listed company, which may or may not be a shell company, with the private company becoming the surviving entity. Upon completion of the transaction, the surviving entity then restructures its capital and offers new shares to the investing public, thus bypassing the tedious, lengthy and complex process of doing an initial public offering.
Some news media mistakenly dubbed the transaction as a consolidation of Tan’s mixed bag of companies into one listed holding company. They further reported that Tanduay might have to issue primary shares (shares not pre-owned by any shareholder) to the investing public since the listed company’s free-float would fall from the pre-merger 14 percent to a post-merger 6 percent, well below the 10 percent floor mandated by the bourse.
Free-float refers to the portion of the listed company’s outstanding shares that is not owned by the controlling and other major shareholders. In other words, these are shares owned by the general public, who hold minority interests in the company.
In the case of Tanduay, the free float would drop significantly after the company issues the new five billion shares to Tan’s Tangent Holdings. To bring free float back up to at least 10 percent, Tanduay only needs to issue less than 380 million shares at P14.66 in a secondary public offering.
Thus, one may see the rationale behind a reverse merger. It was not to consolidate Tan’s diversified holdings into one company – these holdings, after all, were already consolidated under Tangent. Tan could have just listed Tangent via an IPO if he wanted to consolidate his holdings in a listed company.
What the reverse merger accomplished is not the public listing of the seven diversified companies; some of them were already listed, as a matter of fact. What was listed as a result of the reverse merger was Tangent Holdings itself, obviously, which would be renamed LT Group Inc., under the leadership of Tan’s son, Michael G. Tan.
An IPO accomplishes two things: a public listing of the company and the raising of fresh capital. A reverse merger accomplishes the same two things, only that these two are done separately. First comes the listing after the reverse merger. Once the heretofore private company, which is Tangent, becomes publicly listed, all kinds of capital-raising exercises become easily available to it. It may raise new capital via the follow-on offering of common shares, warrants, convertible preferreds, etc.
This was done, furthermore, in a cost-efficient manner since an IPO costs a lot of money, in terms of underwriting and ancillary fees, and management time.
In addition, the reverse-merger route to raising new capital can be less vulnerable to poor market conditions, as the latest events would attest. A conventional IPO would be very much at risk to how the market fares during the float period; poor conditions would mean a no-go for the underwriters and the company would be left holding the bag, all dressed up for a maiden outing in the market but nowhere to go.
A reverse merger also telescopes the process of going public. It can take as much as a year for a company going the IPO route, from the time it contracts an underwriter to the time it sells its first shares in the market. A reverse merger, in contrast, can take as short as a month for a private company to become a publicly listed company.
So, the whole point of this exercise is to list Tangent Holdings through the bourse’s back door. For what reason? One needs to read further into the announcement. Tan also anointed his son, Michael, as his heir apparent, with a leading role in the newly created LT Group. Obviously, Tan did not need a reverse merger to do this – he could have simply made Michael chief executive of Tangent, his formerly unlisted holding company.
Apparently, now almost in his eighth decade, Tan is feeling intimations of his mortality. He has finally decided to formalize his legacy by choosing his heir apparent. He chose to do so in a tax-efficient manner. An opportunity for tax arbitrage exists between the country’s capital gains tax rate for unlisted companies and the stock transaction tax rate of ½ of one percent of the gross selling price for listed companies.
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