THE last couple of years have seen an increase in the number of loss-making public-listed companies diversifying their business to get back into the black or even being taken over by new shareholders without triggering the strict regulations governing reverse takeovers (RTOs).

This has been driven by various factors, including a changing economy. The targets of these exercises seem to be mostly from the manufacturing sector, with property development as a choice diversification venture.

A rough indicator of Malaysia’s manufacturing sector, the Nikkei Manufacturing Purchasing Managers’ Index, has remained below the 50-point mark since end-2014 — with the exception of a handful of months — indicating that the conditions are deteriorating over the past three years.

It is worth noting that several of the diversification exercises have been by garment makers. This is likely the result of intense global competition from low-cost producing countries such as China, India, Bangladesh, Cambodia and Vietnam.

Yong Tai Bhd is one such company that has successfully ventured out of the clothing segment to turn around its operations. It announced plans to venture into property development in April 2014 as the textile manufacturing business dragged it into the red for several years.

The company entered into a collaboration agreement with PTS Properties Sdn Bhd to develop a 29-storey luxury condominium hotel in Melaka.

As the project could contribute 25% or more to Yong Tai’s net profit, the company duly sought shareholders’ approval for the move. Approval was obtained and some boardroom changes followed. In 2015, CEO Datuk Wira Boo Kuang Loon went in with a 7.16% stake.

Last year, Hong Kong-listed Sino Haijing Holdings Ltd’s unit, Impression Culture Asia Ltd, subscribed for a special share issue for a 34.5% stake in Yong Tai. In May this year, Hong Kong-listed Co-Prosperity Holdings Ltd’s unit, Full Winning Developments Ltd, acquired a 24.59% stake in Yong Tai from Impression Culture Asia. Three months later, it raised its holding to 31.34% following a private placement.

After making losses for several years, Yong Tai returned to the black in its financial year ended June 30, 2015 (FY2016), posting a net profit of RM7.73 million.

In April, the group said it was considering disposing of the ailing textile and garment business “in the near future”, but had yet to enter into any formal negotiation or agreement with any party.

A more recent example would be another loss-making apparel retailer, Voir Holdings Bhd, which has proposed to diversify into the construction, property, infrastructure development and toll concession businesses via the acquisition of a 13.21% stake in Consortium Zenith Sdn Bhd.

Voir plans to change its name to Vertice Bhd upon completion of the RM9.86 million related-party purchase. It is also disposing of one of its apparel retailing units, Applemints Apparels.

In April last year, Voir saw the emergence of Vista Lestari Sdn Bhd as its largest shareholder. Vista Lestari has 41.7% equity interest in Zenith Construction Bhd, which, in turn, has a 99.1% stake in Consortium Zenith. Hence, the acquisition of the 13.21% stake is a related-party transaction.

Inter-Pacific Securities Sdn Bhd research head Pong Teng Siew says property ventures are preferred because the projects provide a fast turnaround and greater clarity on investment returns.

“If you invest in a property project, you will be able to see returns in about three or four years. And the returns can be substantial if the project is successful,” says Pong.

“It is a tried and true venture. It is popular because of the profitability and the relatively quick turnaround.”

Another factor is the soft domestic property market, which means that landowners are more willing to give up their land parcels for development.

Other manufacturers that have diversified or are in the midst of venturing into the property business include Boon Koon Group Bhd, Wong Engineering Corp Bhd and Spring Gallery Bhd.

G3 Global Bhd (formerly known as Yen Global Bhd), which manufactures jeans under the Edwin, Mustang and GA Blue brands, was an outlier of sorts as it has chosen to go into the Internet of Things (IoT) business instead.

The company disposed of one of its apparel units, Starix Collection Sdn Bhd, in 2014 due to low sales and high overhead costs in the UK. It is now in the process of selling one of its retail subsidiaries, Twin Access Sdn Bhd.

In December 2015, G3 Global acquired the entire equity interest in Atilze Digital Sdn Bhd (formerly known as VLT Wholesale Sdn Bhd), which sells information and communications technology equipment and IoT products.

A month later, Atilze Digital inked an agreement with Taiwan-listed Gemtek Technology Co Ltd to distribute its products, with Gemtek Technology emerging as a substantial shareholder in G3 Global with a 9.09% stake. Gemtek Technology later raised its holding to 30%.

Then, Green Packet Bhd emerged as a substantial shareholder in G3 Global as well after acquiring a 22% stake for RM18.15 million.

Although these exercises might seem significant due to the material contribution expected from the new ventures and sometimes the entry of a new major shareholder, they did not trigger Bursa Malaysia’s and Securities Commission Malaysia’s (SC) rules governing RTOs.

M&A Securities Sdn Bhd corporate finance head Datuk Bill Tan says this method is an avenue for companies to diversify and turn around their business without being subject to the RTO regulations.

After all, SC’s rules for backdoor listings are almost as stringent as those for initial public offerings. Also, contrary to popular belief, RTO exercises can take just as long as new listings on the local bourse, with some undertaking mandatory general offers, which can be a costly affair.

“If a company diversifies and hits certain ratios, it will have to qualify for an RTO, meaning that it will be subject to the RTO rules, which require a profitability track record,” says Tan, whose firm advised Yong Tai and Boon Koon for their diversification exercises.

He adds that most of the assets these struggling companies want to inject into their operations will not be able to meet the backdoor listing requirements anyway, which is why most are careful not to trigger the RTO regulations.

“I think the SC and Bursa guidelines are too rigid for these companies. In my opinion, there should be flexibility for the management and board to make money for the shareholders. If their business is not doing well, they have to innovate and diversify,” he says.

Based on the SC’s Equity Guidelines, the regulator looks at the percentage ratios of the net asset value of the target acquisition, the revenue attributable to the new asset, profit after tax, aggregate value of the consideration for the subject acquisition and the number of new shares issued by the listed company as consideration for the acquisition.

If any of the ratios are equal to or more than 100%, the SC would deem it as a significant change in the business direction or policy of the company.

Another trigger is an acquisition that results in a change in the controlling shareholder or board of directors of the listed company. Where the acquisitions are done via small stakes, the test would be the aggregate interest accumulated over 12 months.

The fulfilment of any of these criteria will trigger the RTO rules, which come with profit requirements, including having at least RM6 million in profit after tax for the most recent financial year.

On Bursa’s side, the listing requirements state that the issuer must get shareholders’ approval for any transaction that will result in the diversion of 25% or more of the company’s net assets to a widely different operation or if the contribution by the new operation is at least 25% of its net profit. The issuer must also get the SC’s approval for any transaction that results in a significant change in the business direction or policy.

But are the rules too strict? A party familiar with the regulations governing diversification and RTOs says the answer is both yes and no.

“Some say they are too strict because they prefer to introduce things overnight to really change the business. On the other hand, investors want the regulations,” he says, adding that Hong Kong Exchanges and Clearing (HKEX) has even tighter rules.

In fact, some investors have said they prefer stricter rules, such as those imposed by HKEX, he says. HKEX applies what it deems a principle-based test to assess whether an asset acquisition exercise is an attempt to list the asset and circumvent the requirements for new listings.

“But the regulators here don’t think that is the way to go. As long as the company does not breach the threshold to trigger the RTO regulations and does an asset injection gradually without giving shareholders a rude shock, they can allow the exercise.

“The shareholders will also get to vote on the exercise, so there are two layers of protection — the regulators and shareholders,” he says.

Where the asset injection is done gradually and disclosed to Bursa, shareholders can decide whether to stay invested or exit.

He also says the rules on significant business direction changes and RTOs naturally slow down the process to allow sufficient notice to shareholders.

Companies are also allowed to present their case to the SC when a significant acquisition involves an asset that is in a similar industry as the company’s existing operations — for example, Pos Malaysia Bhd’s takeover of KL Airport Services Sdn Bhd (now Pos Aviation Services Sdn Bhd) last year, which saw the emergence of HICOM Holdings Bhd as the largest shareholder with a 31.39% stake, and the three-way merger between Faber Group Bhd (now UEM Edgenta Bhd), Opus Group Bhd and Projek Penyelenggaraan Lebuhraya Bhd in 2014.

“In Pos Malaysia’s case, they proved that KLAS was part of the logistics chain and not an RTO. Similarly, Opus was part of the maintenance chain,” the person says.

AmInvestment Bank Bhd executive vice-president and head of equity markets Gan Kim Khoon says the regulations should remain tight to protect the interests of minority shareholders.

“The rules are there to ensure quality listings. Of course, we will always have certain parties that wish the rules are relaxed so that they can circumvent or bypass the RTO process,” he says.

Despite the strict RTO regulations, the demand for backdoor listings remains.

Among the pending exercises are Wellspring Worldwide Ltd’s RTO of loss-making SMTrack Bhd and the potential RTO of Wintoni Group Bhd by an engineering services group.

There have also been several successful RTOs over the past few years. They include Eco World Development Group Bhd’s RTO of Focal Aims Holdings Bhd, WMG Holdings Bhd’s takeover of Tekala Corp Bhd, Rohas-Euco Holdings Sdn Bhd’s RTO of Tecnic Group Bhd and GFM Services Bhd’s RTO of AsiaEP Resources Bhd.