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Sunday, 20 July 2014 19:06

Trio of West Michigan companies turn to reverse mergers to go public

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Electronic Cigarettes International Group Chairman and CEO Brent Willis cautions that reverse mergers with public shell companies are not for every company, but the move helped his firm access millions in much needed capital as it looks to consolidate the highly fragmented e-cigarette industry. Electronic Cigarettes International Group Chairman and CEO Brent Willis cautions that reverse mergers with public shell companies are not for every company, but the move helped his firm access millions in much needed capital as it looks to consolidate the highly fragmented e-cigarette industry. PHOTO: Mark Sanchez

Aiming to become a global leader in the emerging $3.5 billion e-cigarette industry, closely held Victory Electronic Cigarettes Corp. began exploring options early last year to raise capital for acquisitions and position itself for growth.

The Nunica-based company investigated several options including finding private equity investors, floating an initial public offering, or executing a reverse merger, according to Chairman and CEO Brent Willis.

In the end, the company, which recently changed its name to Electronic Cigarettes International Group Ltd., chose the reverse merger route because it offered a quicker, lower-cost way to go public than an expensive, regulatory-laden IPO process.

In a reverse merger, a private company gets acquired by a public company, but the shareholders of the private company become the majority owners of the surviving publicly traded company.

In June 2013, Electronic Cigarettes International Group merged with a Nevada-based public shell company, Teckmine Industries Inc. The entire process took just three months and cost about $50,000 — about half the time and a third of the cost required in a typical IPO.

“Life is short,” Willis said. “If you are going to step up to the plate, don’t bunt. Swing for the fences.”

Electronic Cigarettes International Group is one of at least three West Michigan-based companies that went public via the reverse merger route during the past year. The deals all happened quickly, which is typical of reverse mergers.

With a reverse merger, “you can accomplish in weeks what it takes months to accomplish in a traditional public offering,” said attorney Tracy Larsen, managing partner for the Grand Rapids office of Barnes & Thornburg LLP.

Agility Health Inc. in Grand Rapids, a fast-growing physical therapy provider, last year executed a reverse merger with a public shell company whose majority shareholders include Agility’s management team. Agility merged with Toronto-based Thornapple Capital Inc., which is listed on the Toronto Stock Exchange. At the time of the transaction, CEO Steve Davidson explained that it would allow Agility Health to quickly issue a private stock placement or register and begin selling shares publicly to raise additional capital to support an ambitious growth plan.

The third local example is Grandville-based Alternaturals Inc. (OTCPink: ANAS), which executed a reverse merger in December 2013 with Nevada-based Premier Mortgage Resources Inc. The company, whose listed address is a mail forwarding service in Grandville, markets itself as a seller and manufacturer of alternative health care products, including several marijuana-based items.


GOING PUBLIC

Reverse mergers — also referred to as a “back-door public offering” — hold benefits for private companies by providing them a public structure, a path to monetize their equity and a vehicle to access public capital markets. The shell company usually survives the merger and the shareholders in the private company become the majority holders of shares in the public company.

While reverse mergers have somewhat of a dubious reputation, the move has worked well so far for Electronic Cigarettes International Group, which has annual sales of more than $200 million. Through acquisitions and organic growth, the company’s market capitalization has grown from $12.5 million to $685.0 million as of last week, and its stock has traded at between $8 and $9 per share, versus 25 cents at the time of the transaction in mid-2013.

At Electronic Cigarettes International Group, the maneuver generated $2 million in capital from investors that went toward building the company’s foundation and expanding distribution.. The company has since done a series of private placements and is now working on an upcoming $150 million public stock offering that will allow the company “to compete in the big leagues,” Willis said.

“It’s made our investors very happy, but it’s not the norm of what can happen,” Willis said.

Just last week, the company secured a $60 million equity investment from Man FinCo Ltd., the investment arm of the Mansour Group, which itself is one of the largest companies in Africa and the Middle East. Mansour Group, which is involved in businesses that range from automotive and heavy equipment to consumer goods, services and retail, initially invested $20 million in Electronic Cigarettes International Group with an option for an additional $40 million.The former Spartan Stores Inc. went public in 2000 in a reverse merger with Seaway Food Town Inc. in Toledo, Ohio. Spartan, which has since become SpartanNash Co. through the $1.3 billion all-stock merger in 2013 with Nash Finch Co. in Minneapolis, Minn., declined to comment to MiBiz on its experience with a reverse merger.

Attorneys who have been involved in examining or structuring such deals, as well as Willis, urge any company that may consider a reverse merger to tread cautiously.

“You are inheriting any liabilities that are in that shell company,” said Peter Roth, an M&A attorney and a partner at Varnum LLP in Grand Rapids.

Despite that concern, a reverse merger is “another tool in the toolbox” for companies that may want to go public to raise needed capital, Roth said.

“With the right setting and the right people, it can be the right option,” he said.


NOT AN OPTION FOR ALL

Even so, reverse mergers historically have not been a favored way to go public “because of some of the abuses that have existed,” Larsen said.

“Some of the shell companies that have been used for back-door public offerings in the past have been fraught with some unknown liabilities. They often have not been met with some of the advantages they have sought to be gained,” Larsen said. “Although there have been some examples where reverse mergers have been successful, there have been many more examples where they have been unsuccessful in delivering the advantages that were sought.”

Larsen has worked with several clients over the years that considered a reverse merger. However, none opted to go forward, often because they were too small to become a public company or were unable to afford the related regulatory compliance costs, he said.

“We’ve never found one that would make economic sense to us,” Larsen said.

Electronic Cigarettes International Group hopes to become the exception. Even with the success so far that his company has had with a reverse merger, Willis said the structure is clearly not an option for everybody.

“It’s tricky and there are going to be risks and pitfalls, and unless you are really good and a little bit lucky, you can easily get into trouble and lose the value you are trying to create with going to a public company,” Willis said.

One potential pitfall of a reverse merger is bringing aboard investors with a short-term view who may quickly sell their shares after a run up in the stock price.

Don Hunt, a managing director at the public relations and investor relations firm Lambert, Edwards & Associates Inc. in Grand Rapids, said key to executing a successful reverse merger is to have good material news in the initial six to 18 months after the deal that makes investors want to hold on to their shares for the long term.

“Otherwise you’re going to have people take money off of the table,” Hunt said.

When searching for a public shell to merge into, companies need to take care to find the right investment partners who are willing to hold their shares for a long period, Willis said.

“You have to do it with the right people and you have to be in a position where the entire float of the trading shares is patient capital,” he said. “You have to be very careful about the people you bring in. If they don’t have alignment with you, they’ll push the price down as soon as they can take the profit.”


CHALLENGES ABOUND

Other potential drawbacks are that executives at private companies tend to have little or no experience running public companies, “and there’s a significant learning curve between being a public company and a private company,” Larsen said. Additionally, companies often never generate the capital they hoped to secure or their stock remains lightly traded, limiting the ability to fashion future acquisitions to drive growth, he said.

“A thinly traded stock is not much of an acquisition currency,” he said.

Federal securities regulators in 2011 also enacted new rules that require companies going public through a reverse merger to raise at least $40 million in a public offering before trading on a major exchange such as Nasdaq, or to have their shares traded over the counter or on a foreign exchange for a year, according to Larsen.

Before a company considers a reverse merger, Roth first urges them to answer the fundamental question of “is being a public company the right option for your business.”

“If your answer is ‘yes,’ then you have to pick the right option,” he said.

Roth also notes that a reverse merger is merely a quick and less expensive way to go public. Raising capital, and the associated costs and regulatory hurdles involved, comes next.

Willis calls Electronic Cigarettes International Group’s reverse merger the first step of executing a far broader growth strategy. The transaction gave the company a public structure. Next up is the $150 million public stock offering, or “re-IPO” as Willis calls it.

“To me, a reverse merger is step one of multiple steps,” Willis said. “You need to have the vision in mind of what the (next) steps are.”

Electronic Cigarettes International Group’s shares presently trade on the Over the Counter Bulletin Board (OTC). The company, after completing the public stock offering, plans to move to the Nasdaq exchange and trade under the ticker symbol ECIG. The company now produces its electronic cigarettes in southern China and hopes to move production to the U.S., preferably in Michigan, Willis said.


IN THE SPOTLIGHT

Although reverse mergers historically have not occurred in high volume, they are at least drawing attention and consideration.

Five or six years ago, Varnum’s Roth rarely heard about it. Today, every few months, one of his peers asks him about the option, said Roth, who still sees few of the transactions occurring.

“I hear it talked about more than done, actually,” Roth said.

Hunt at Lambert Edwards said as long as the IPO market “still isn’t what I call furtive,” he expects to see reverse mergers remain an option for a company in the right circumstances to consider to raise capital.

“You’re always going to have people looking for the most cost-efficient way to raise capital,” Hunt said. “It’s all about what is the shortest distance between where a company is at and a good, smart capital raise, and everybody is going to be a little different.” 

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