Nothing excites the market more than a backdoor listing. A mere whisper of the words “backdoor listing” is enough to lift a shell company from obscurity to one of the most actively traded stocks, often resulting in hefty gains for traders who are brave enough to buy the rumor.
For context, a backdoor listing is when a private entity buys a controlling stake in a listed company, usually a non-operating or shell company, with the intent of merging with it and thus becoming publicly listed.
After being in the market for more than a decade, I have witnessed several backdoor listings, and experience has taught me one key thing: one must be swift to exit.
The price action typically starts as soon as the parties to the transaction sit down to negotiate the terms, and usually lasts until the listed company discloses to the Exchange that a deal has been reached. This disclosure will trigger a trading suspension that will only be lifted once the full details of the transaction are submitted.
This can last anywhere from a few days to several weeks, which is bound to be a very anxious period for shareholders who have been locked in.
The final disclosure, when it finally comes, is almost always a disappointment as the agreed price is typically much lower than the market price, which means that the succeeding tender offer for the remaining shares will also be very low.
On top of that, the private company seeking to list via backdoor is rarely as exciting or profitable as initially thought. As a result of this, the share price usually plummets as soon as the trading suspension is lifted.
Another important thing to note is that companies seeking to list through this method are also required to conduct a follow-on offer of at least 10 percent of its outstanding shares within one year. This means that existing shareholders run the risk of being diluted if they do not participate in the offer.
We are not saying that there is anything wrong with participating in backdoor plays. After all, it can be a fun and profitable ride if one plays their cards right.
It t is also important to remember that companies who opt to list using this method often do so because they are unable to meet the profitability and capitalization requirements for a traditional IPO. As such, they are hardly what we would classify as a good investment.
There are always exceptions. In fact, three out of the 30 index names were listed through the backdoor, which goes to show that a stock can go from relative obscurity to being a blue-chip stock.
However, even these three blue-chip stocks are now trading at prices that are well below the highs they reached in the speculative run-up prior to the announcements of their backdoor listing.
This further drives home the point that one must be cautious when buying into backdoor stories, and to never assume that a stock’s price will continue to go up just because it has transformed from a shell company to one that actually has operations. After all, we all know that today’s hottest stock can later be the market’s hottest potato that nobody wants to hold on to.
