Scrap the public float rule
11 June 2013
Investors in SCMP Group Ltd (SCMP, 0583), publisher of the South China Morning Post, must be growing weary of the repeated long-term suspension by the Stock Exchange of dealings in their shares, after another 3 months in the deep freeze. This is through no fault of their own, or even of the company, because this is entirely a matter of the Listing Rules and the ownership structure. They are not the only ones to be impacted by Listing Rule 8.08. In this article we will explain by the rule requiring a 25% public float should be scrapped, because it has no real purpose, and because the only way to enforce it is to victimize minority shareholders by suspending their shares from trading.
On 13-Dec-2007, the Kuok family's Kerry Media Ltd (Kerry) bought 3.20% of SCMP at $2.39 in an off-market transaction, raising its stake (including its associates) to 44.85%. That was more than the 2% per year "creeper" allowance (for creeps) under the Takeover Code, so it resulted in a mandatory general offer at the highest price paid within the previous 6 months, which was $2.75. The offer closed on 25-Feb-2008 with acceptances and purchases during the offer period raising the stake to 74.93%. This was despite the advice from Platinum Securities Co Ltd in the response document, advising independent shareholders not to accept the offer.
As of 21-Mar-2007, Silchester Partners Ltd (Silchester, UK), an asset manager and long-term substantial shareholder, held 14.00%. They did not accept the offer, and as they are over 10%, under the Listing Rules they do not count towards the public float requirement of 25%. As a result, on 27-Feb-2008, the Stock Exchange suspended the shares on the grounds that the remaining public float was below 25%, freezing the minority shareholders. On 6-Mar-2008 SCMP announced that Silchester held 14.06%, leaving a public float of 11.01%.
A whole year went by, then on 27-Feb-2009, Kerry agreed with 3 investment banks, JPMorgan Chase Bank, Deutsche Bank and Bank of East Asia (BEA, 0023), to "sell" 225m shares (14.4%, one-third to each bank) at $1.70 (38% discount to market), and the banks had the right to sell them back to Kerry on the 4th anniversary at a price which would give the banks a return of 1.1% p.a., which we will call a "parking fee". Kerry also had the right to require the banks to exercise the put options at any time, so in effect Kerry held a call option at the same price.
The combination of a long put and short call is virtually the same as a forward sale, because it is in the interests of one side or the other to exercise their option, assuming they have a common view on the value of the shares. To make things air-tight, Kerry deposited the proceeds of the "sale" with the same 3 banks, as collateral for its future payment under the put options. Any dividends reduced the exercise price of the option, allowing Kerry to withdraw the same amount from the collateral (less the accrued parking fee). In theory, the banks could have sold the shares in the market at above the put price (if such a price was available), but then if Kerry called the shares back by requiring the banks to exercise the put option, the banks would have to repurchase the shares in the market, so that was never likely to happen.
In short, this was an arrangement to park shares with banks for 4 years, in order to technically satisfy Listing Rules on the public float without actually reducing Kerry's economic interest or increasing the number of shares in circulation in the market. It worked. With the blessing of the Stock Exchange to this highly contrived arrangement, trading resumed in the afternoon of 2-Mar-2009, with a purported public float of 25.12%, including the 14.4% held by the banks.
Apart from the parking fee and expenses, Kerry also paid the banks an undisclosed advisory fee. It is worth mentioning at this point that David Li Kwok Po, the Chairman and CEO of BEA, has been an INED of SCMP since its IPO in 1990. Kuok Khoon Ean, then Chairman of SCMP and son of Kerry's founder Robert Kuok Hock Nien, has been an INED of BEA since 10-Jan-2008, and fellow Malaysian tycoon Khoo Kay Peng has been an NED of SCMP since 25-Jun-1994 and of BEA since 15-Oct-2001.
Roll the clock forward 4 years, and on 7-Feb-2013, Kerry triggered the options, reducing the official public float back to 10.59%, so SCMP warned investors that upon completion on 26-Feb-2013, the stock would again be suspended. And so it was. Investors have now spent more than 3 months without access to their capital.
There is another way to avoid the free float rule. Create a new class of non-voting securities which have all the same economic attributes as the shares (as to dividends, capital on liquidation, and so on) but are not listed or transferable, and then declare a bonus issue in which shareholders can elect to receive either ordinary shares or the new unlisted securities. The majority shareholder then accepts the unlisted securities, reducing his percentage of the ordinary shares and thereby restoring the free float without making any change to the economic value of the free float or to his economic interest in the company.
An early example of this was Sunevision Holdings Ltd (Sunevision, 8008). On 9-Sep-2010, it announced a 1:1 bonus issue, with the option of receiving unlisted, irredeemable non-transferable convertible notes instead. Sunevision was 84.64% owned by Sun Hung Kai Properties Ltd (SHKP, 0016) and they needed to increase the float by 30-Jun-2011 when the Listing Rules were changed to require a 25% float. By electing to receive the notes, SHKP's shareholding was cut to 73.37%, while its economic interest remained at 84.64%.
A more recent example is Top Spring International Holdings Ltd (Top Spring, 3688). On 28-Jan-2013, it announced that its public float had dropped below 25% and was then 20.64%. On 27-Mar-2013 it announced a 2:5 bonus issue of shares with an alternative of unlisted perpetual subordinated convertible securities. This would raise the public float to 25.14%, assuming nobody but the chairman elected to receive the convertibles. His voting interest would drop, but his economic interest would remain the same.
Again, these arrangements satisfy the Listing Rules but make no difference to the economic value (or market capitalisation) of the publicly held, tradable shares. In that respect, the costs incurred in terms of legal fees, printing and advisory fees are a waste of shareholders' money purely to satisfy a Listing Rule.
The float rule lacks a proper purpose
What is the purpose of the public float rule? If it is to provide some minimum value of tradable shares, then it fails, because there are plenty of companies whose entire market value is less than the public float of SCMP and yet they are not suspended, and because it is easily circumvented with a bonus share scheme which does nothing to increase the market value of the public shares.
There is full disclosure of insider shareholdings, so investors are aware (if they choose to be) what the public float of any company is. Furthermore, if a major shareholder in a listed company keeps buying the shares, by reducing the float he is making it easier to block an eventual privatisation and delisting, because it only takes 10% of the minority shares to veto such a deal. So without a free float rule, major shareholders would be unlikely to push it that far.
As the SCMP case demonstrates, the float rule is in practice unenforceable, because the Listing Rules and the Listing Agreement are a contract binding companies, not shareholders. Companies cannot force their shareholders to sell, or to buy in privatisation offers. Even the bonus share manoeuvre described above requires shareholder approval, which may not be forthcoming. SCMP has recently said that Kerry will not support such a move. Perhaps it suits them to freeze Silchester and all the other minority shareholders, by refusing to support an artificial bonus share scheme which would restore the public float. It might make it easier to squeeze them out with another low privatisation offer.
If this is a question of voting rights, then from a minority shareholder perspective, it makes little difference to the balance of power whether the major shareholder owns 70% or 90%. With 75% you can pass a special resolution to change the articles of association even if all the other shareholders vote against it. Turnouts in shareholder meetings are never 100%, so in practice you can absolutely control a company with 70%, and of course you can absolutely elect or remove any director with a 50% majority of the votes cast in general meetings.
The public float rule places minority shareholders in all companies at constant risk of having their shareholdings frozen by the Stock Exchange despite the fact that neither they, nor the company, have done anything wrong, but purely because of the actions of other shareholders. That risk is obviously higher in situations with two substantial shareholders where, for their own economic reasons, neither of them wishes to sell.
Scrap the rule
The public float rule should be scrapped. Let the market trade. The market has full information on what the substantial shareholdings over 5% are (to the nearest whole percent) as required by law. Investors can make their own choice over whether they want to own shares in a small percentage float, whether it is a large company or a small one. Investors should not have to pay, via their companies, to execute convoluted bonus share schemes just to comply with the Listing Rules, and should not be at risk of having their money frozen in suspended shares purely because of the actions of other shareholders. This rule is not serving investor interests.
© Webb-site.com, 2013
Organisations in this story
- Great Wall Pan Asia Holdings Limited
- Kerry Media Limited
- SUNEVISION HOLDINGS LTD.
- Top Spring International Holdings Limited