Reverse Takeovers — The Worrying Trend on the ASX

Imagine you run a business. You might actually already run a business, so this could be easy for you. But if you don’t, just use your imagination.

Picture you started this business from scratch. You built it from the ground up. You had a good idea, and you decided to make something of it. Now if you run this business, what’s the very first thing you want to achieve?

The answer is simple. Sales. You want to sell whatever it is your business sells. You do this to make money. You want to increasingly sell more of it and make more money for the business. You want it to grow. You want it to get bigger. You want to turn your business from an idea into something that can provide a way of life for you, your family and maybe even generations to come.

The only way you can make your business a success is for it to grow.

One day your company gets big enough that you think it might be time to take it public. That means listing the company on the stock exchange. It means selling shares to investors who can profit in its success.

Or one day you might be asked to take your business public, but you decide you don’t want to. Its growth is good enough that you don’t need outside investment. You don’t need shareholders. You can make it a big, successful private company.

There’s nothing wrong with staying as a private company. Some of the world’s most successful companies are still private. IKEA for instance is a private company. Red Bull is a private company. Uber is a private company. None of these are publicly traded companies. Yet all of them are worth tens of billions.

They don’t see the need to go public (although Uber might at some point). They don’t see the need because there is no need. Going public isn’t the ‘thing you do’ all the time, but for some businesses it’s the cheats way of funnelling capital into a company to artificially grow.

There’s a worrying trend on the ASX

Back to this fictional company you run. Let’s say your company is still in its early stages of incorporation. You might not even be a year old yet. Heck, you might have only created the company five or six months ago.

As it stands you make $0. That’s right, you have not sold any products, services or licences. Your company makes absolutely no money at all. Or perhaps you might make a few thousand dollars. At best say $100,000.

That’s not much is it? You probably got paid more when you were working for someone else as an employee. Now consider taking your company public. You make no money, or a negligible amount at that. And you’re now deciding to take your company and list it on the Australian Stock Exchange.

By listing you hope to raise a few million in capital. How do you place a value on your company? How much capital do you need to raise? Well you make no money, so you can’t value your company in a traditional sense. It’s all a bit ‘throw a dart blindfolded’ isn’t it?

Let’s be honest though, if you ran a company that didn’t make any money yet, you’d be pretty bonkers to list on the ASX. All good business sense suggests you should build up the company and get a few contracts and revenues through the door before even considering such a blind leap of faith…

Except ‘all good business sense’ doesn’t always ring true.

A few key words and a website does not maketh the company

There’s a worrying trend of new, small companies that are coming to the ASX via reverse takeovers (RTOs). That where a company (usually worth nothing) decides to ‘buy’ a new tech company through the issue of shares, performance shares, options and a bit of cash.

What’s worrying though is some of these new tech companies are barely a year old. Most of them barely make any money. Some make no money at all. Some haven’t sold a single product, service or licence. Yet here they are now a publicly traded company. They’re raising millions of dollars from investors on smoke and mirrors. Nothing tangible but a patent, usually the words ‘cloud-based’ and a non-executive director or two that’s got a bit of a tech background.

The worst part is they’re easily meeting their capital raising targets. Often oversubscribed. They’re trading on the promise and hope of revenues, contracts, big deals and big stock gains. But the reality is they will often come with stock dilution, capital raisings, and quite possibly even failure.

You only need to scan through the ASX announcements list on the ASX homepage to see for yourself. Look for announcements titled, ‘Suspension from Official Quotation’ or ‘Supplementary Prospectus’.

Then see if the announcement speaks of a ‘change in business direction’. That typically means an RTO. Or if the supplementary prospectus is to fix errors in the first, second or third prospectus — because they rushed them all to market.

We make no money, but invest anyway

Before you know it, these junior resources companies become tech companies. It’s an alarming trend. On Tuesday this week on the ASX you could find three examples, Firestrike Resources [ASX:FIE], Paradigm Metals Ltd [ASX:PDM] and Synergy Plus Limited [SNR].

PDM is ‘buying’ IODM, an online ‘cloud-based’ debt collection company. FIE is ‘buying’ Linius, a video delivery technology company. SNR is ‘buying’ VGW Gaming Ltd, a social (online) casino company.

But get this, in the prospectus for Linius they explicitly state,

Linius (Aust) has limited trading history and has generated no operating revenue to date. It is now focussed on the commercialisation and further development of the Linius technology.’

VGW is a different kettle of fish. They make money, they have around $27 million come through the doors from their 10,000 players. They’re an online casino. Don’t let ‘social gaming’ confuse you, this is as good as playing the pokies…just online. And they don’t even have Aussie customers. Their prospectus highlights that,

VGW Holdings has over 10,000 paying players per month, most of whom are based in the United States and Canada (excluding Quebec).

Their main platform is Facebook. That’s how they get away with using the terminology ‘social gaming’. But it’s a casino, made to look like fun games you can play with your friends, and advertised through Facebook.

Look, I’m not here to beat down companies that slip through the back door onto the ASX. Some of them go on to be fantastic, profitable, large companies. But many of them will not. The feeling I get is there’s a race to get on the ASX because it’s a fast track way to access investor funding.

Defunct junior miners are providing the easy access. And the rush of tech companies through these RTOs is alarming. They’ll be the kinds of companies you hear about from a mate of a mate. Flying under the radar — but do your due diligence. The way I see it, many of these companies aren’t worth the junior miner they listed on. And they’ll burn plenty of investors that get sucked into the hype.


Sam Volkering is an Editor for Money Morning and is small-cap, cryptocurrency and technology expert.

He’s not interested in boring blue chip stocks. He’s after explosive investments; companies whose shares trade for cents on the dollar, cryptocurrencies that can deliver life-changing returns. He looks for the ‘edge of the bell curve’ opportunities that are often shunned by those in the financial services industry.

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