A reverse takeover enables a private, unlisted company, like Chrysos Co, to gain a listing on the stock exchange without needing to go through the process of an initial public offering (IPO). The private company merges with a listed ‘shell’ company. The private company initially purchases equity shares in the listed company and takes control of its board of directors. The listed company then issues new equity shares and these are exchanged for equity shares in the unlisted company, thereby the original private company’s equity shares gain a listing on the stock exchange. Often the name of the listed company is also changed to that of the original unlisted company.

Advantages relative to an IPO

1. An IPO can take a long time, typically between one and two years, because it involves preparing a prospectus and creating an interest among potential investors. The equity shares need to be valued and the issue process needs to be administered. Since with the reverse takeover shares in the private company are exchanged for shares in the listed company and no new capital is being raised, the process can be completed much quicker.

2. An IPO is an expensive process and can cost between 3% and 5% of the capital being raised due to involvement of various parties, such as investment banks, law firms, etc, and the need to make the IPO attractive through issuing a prospectus and marketing the issue. A reverse takeover does not require such costs to be incurred and therefore is considerably cheaper.

3. In periods of economic downturn, recessions and periods of uncertainty, an IPO may not be successful. A lot of senior managerial time and effort will be spent, as well as expenditure, with nothing to show for it. On the other hand, a reverse takeover would not face this problem as it does not need external investors and it is not raising external finance, but is being used to gain from the potential benefits of going public by getting a listing.

Disadvantages relative to an IPO

1. The ‘shell’ listed company being used in the reverse takeover may have hidden liabilities and may be facing potential litigation, which may not be obvious at the outset. Proper and full due diligence is necessary before the process is started. A company undertaking an IPO would not face such difficulties.

2. The original shareholders of the listed company may want to sell their shares immediately after the reverse takeover process has taken place and this may affect the share price negatively. A lock-up period during which shares cannot be sold may be necessary to prevent this. [NB: An IPO may need a lock-up period as well, but this is not usually the case.]

3. The senior management of an unlisted company may not have the expertise and/or understanding of the rules and regulations which a listed company needs to comply with. The IPO process normally takes longer and is more involved, when compared to a reverse takeover. It also involves a greater involvement from external experts. These factors will provide the senior management involved in an IPO, with opportunities to develop the necessary expertise and knowledge of listing rules and regulations, which the reverse takeover process may not provide.

4. One of the main reasons for gaining a listing is to gain access to new investor capital. However, a smaller, private company which has become public through a reverse takeover may not obtain a sufficient analyst coverage and investor following, and it may have difficulty in raising new finance in future. A well-advertised IPO will probably not face these issues and find raising new funding to be easier.

Report to the board of directors (BoD), Chrysos Co
This report provides extracts from the financial position and an estimate of the value of Chrysos Co after it has undertaken a restructuring programme. It also contains an explanation of the process used in estimating the value and of the assumptions made. Finally, the report discusses the impact of the restructuring programme on the company and on venture capital organisations.
It is recommended that the manufacturing business unit is unbundled through a management buy-out, rather than the assets being sold separately, and it is estimated that Chrysos Co will receive $3,289m from the unbundling of the manufacturing business unit (appendix one). This amount is recorded as a cash receipt in the extract of the financial position given below.
Extract of Chrysos Co’s financial position following the restructuring programme

Estimate of Chrysos Co’s equity value following the restructuring programme
It is estimated that Chrysos Co’s equity value after the restructuring programme has taken place will be just over $46 billion (appendix three).
Process undertaken in determining Chrysos Co’s equity value
The corporate value is based on a growth rate of 4% on cash flows in perpetuity, which are discounted at Chrysos Co’s cost of capital (appendix two). The cash flows are estimated by calculating the profit before depreciation and tax of the unbundled firm consisting of just the mining and shipping business unit and then deducting the depreciation and taxation amounts from this.
The bank loan debt is then deducted from the corporate value to estimate the value of the firm which is attributable to the equity holders (appendix three).
Assumptions made in determining Chrysos Co’s equity value
It is assumed that Sidero Co’s ungeared cost of equity is equivalent to Chrysos Co’s ungeared cost of equity, given that they are both in the same industry and therefore face the same business risk. Modigliani and Miller’s proposition 2 is used to estimate Chrysos Cos’s restructured cost of equity and cost of capital.
It is assumed that deducting depreciation and tax from the profit before depreciation, interest and tax provides a reasonably accurate estimate of the free cash flows (appendix three). Other adjustments such as changes in working capital are reckoned to be immaterial and therefore not considered. Depreciation is not added back because it is assumed to be the same as the capital needed for reinvestment purposes.
It is assumed that the cash flows will grow in perpetuity. The assumption of growth in perpetuity may be over-optimistic and may give a higher than accurate estimate of Chrysos Co’s equity value.
(Note: Credit will be given for alternative and relevant assumptions)
Impact of the restructuring programme on Chrysos Co and on the venture capital organisations (VCOs)
By acquiring an extra 600 million equity shares, the proportion of the VCOs’ equity share capital will increase to 40% ((600m + 20% x 1,800)/(1,800 + 600)) from 20%. Therefore, the share of the equity value the VCOs will hold in Chrysos Co will increase by $9,229m, which is 77·5% more than the total of the value of bonds cancelled and extra payment made (appendix four). As long as the VCOs are satisfied that the equity value of Chrysos Co after the restructuring programme has been undertaken is accurate, the value of their investment has increased substantially. The VCOs may want undertake a feasibility study on the annual growth rate in cash flows of 4% and the assumption of growth in perpetuity. However, the extent of additional value created seems to indicate that the impact for the VCOs is positive.
By cancelling the VCOs’ unsecured bonds and repaying the other debt in non-current liabilities, an opportunity has been created for Chrysos Co to raise extra debt finance for future projects. Based on a long-term capital structure ratio of 80% equity and 20% debt, and a corporate value of $47,944m (appendix three), this equates to just under $9,600m of possible debt finance which could be accessed. Since the bank loan has a current value of $1,800m, Chrysos Co could raise just under an extra $7,800m debt funding and it would also have $1,439 million in net cash available from the sale of the machinery parts manufacturing business unit.
Chrysos Co’s current value has not been given and therefore it is not possible to determine the financial impact of the equity value after the restructuring has taken place on the company as a whole. Nevertheless, given that the company has access to an extra $7,800m debt funding to expand its investment into new value-creating projects, it is likely that the restructuring programme will be beneficial. However, it is recommended that the company tries to determine its current equity value and compares this with the proposed new value. A concern may be that both the five senior equity holders’ group and the 30 other equity holders group’s proportion of equity shares will reduce to 30% from 40% each, as a result of the VCOs acquiring an additional 600 million shares. Both these shareholder groups need to be satisfied about the potential negative impact of these situations against the potential additional benefits accruing from the restructuring programme, before the company proceeds with the programme.
Conclusion
The restructuring programme creates an opportunity for Chrysos Co to have access to extra funding and additional cash for investment in projects in the future. The VCOs are likely to benefit financially from the restructuring programme as long as they are satisfied about the assumptions made when assessing the value created. However, Chrysos Co will need to ensure that all equity holder groups are satisfied with the change in their respective equity holdings.
Report compiled by:
Date:
(Note: Credit will be given for alternative and relevant points)
Appendices
Appendix One: Unbundling the manufacturing business unit
Option 1: Sale of assets
Net proceeds to Chrysos Co from net sale of assets of the manufacturing business unit are $3,102 million.
Option 2: Management buy-out

Estimated value = ($435m x 1·08)/0·10 = $4,698m
Amount payable to Chrysos Co = 70% x $4,698m = $3,289m
The option to unbundle through a management buy-out (option 2) is marginally better for Chrysos Co and it will opt for this.
Appendix Two: Calculation of cost of equity and cost of capital