Listing a company on the bourses is a cumbersome process. Host of guidelines/regulations, past track record and unfavourable primary market conditions can act as a hindrance. However, promoters of many unlisted companies have found a way out to get themselves listed by evading the current clumsy process. And that is by acquiring listed shell companies. For the uninitiated, a shell company is an organisation which does not have any business or assets in place. Acquiring such companies gives a ready platform to promoters of the unlisted entity, to subsequently merge their business with the shell company. This gives them a backdoor entry to Dalal Street.
Reverse merger transactions (merging the listed company with the unlisted one) are especially favourable during weak market conditions. This is because during such times listed shell companies generally trade at a discount. And thus, the promoter of the unlisted entity does not have to pay a huge premium to the current market price. In fact, there have been a quite a few shell acquisitions in the recent past due to weak market conditions.
But one must remember that such acquisitions can also backfire as shell companies are fraught with accounting irregularities and weak corporate governance practices. Take the case of US shell companies for example. Off late, many Chinese companies had gotten themselves listed in the US through reverse merger transactions. However, as accounting scandals in these shell companies started coming on to the fore (resulting from intense scrutiny), many traders indulged in short selling in order to make a quick buck. This not only resulted in huge price erosion but few of them also got delisted in the said process.
Another issue with shell companies is that since they having no business of their own, the intrinsic value and the acquisition premium paid, is always under question. There is no way an unlisted promoter can come to a fair value of a non-existent business. Also, the acquisition premium he is willing to pay is dependent on his willingness/need to get himself listed. Thus, we believe that gaining a backdoor entry through shell acquisition is a dangerous way to go public. If the business has strong fundamentals, the traditional Initial Public Offer (IPO) route is much safer.