This is an extract from an article that was published in the Hong Kong Stock Exchange's “Listing in Hong Kong Bi-Monthly Newsletter” authored by Teresa Ko, Grace Huang and David Cotton.
What is a spin-off and what is driving the trend for these?
A spin-off IPO is a separate listing of part of an existing listed company’s assets or businesses. They can range from the spin-off of a business that is already distinct from the rest of the parent group – such as the spin-off of HK Electric Investments from Power Assets - to more complex transactions where part of an existing business is carved out on a geographical or other basis – such as the spin-off of Langham Hospitality Investments, which involved the spin-off of Great Eagle’s Hong Kong hotel assets, with Great Eagle retaining its hotel assets elsewhere in the world.
A spin-off creates a vehicle which is focussed on a particular business or with a particular geographical focus, which can pursue a strategy independent from that of the parent. This may attract investors that would not have invested in the parent due to its broader range of activities, potentially increasing overall shareholder value as a result. The large number of conglomerates in Hong Kong and China has meant that it is fertile ground for spin-off transactions.
The need to demonstrate independence from the parent
Under the Hong Kong listing rules, there are two fundamental requirements that apply to spin-off listings, whether the parent is a Hong Kong listed company or not:
- Firstly, the entity being spun off must be capable of carrying on its business independently of its parent. This is looked at in terms of operational, management and financial independence. In particular, an entity being spun-off cannot rely on its parent to such a degree that it would be unable to operate its business if the parent ceased to support it. Where the parent and entity being spun-off will continue to transact with each other post listing, these transactions will be subject to strict limits and, typically, a requirement for independent shareholder approval every three years unless the de minimis exceptions apply.
- Secondly, where the parent has a business which competes or is likely to compete with the business of the entity being spun-off, there must be sufficient delineation between those businesses and other protections in place (e.g. non-compete undertakings or right of first refusal or call option arrangements).
Protecting the parent’s shareholders
Spin-offs from Hong Kong listed companies are in addition subject to the requirements of Practice Note 15 (PN15). Before the spun-off entity files its listing application in Hong Kong or elsewhere, the parent must make a PN15 application and obtain the approval of the Stock Exchange. As well as looking at the independence and competition points from the point of view of the parent, PN15 requires a parent to satisfy the Stock Exchange that it is itself able to satisfy the requirements for a listing after the spin-off and there are clear commercial benefits for the parent and entity being spun-off, and that there will be no adverse impact on the interests of shareholders of the parent. The Stock Exchange would be concerned to see that one business is not supporting two listings (i.e. that of the parent and the spun-off entity). A spin-off transaction will also require the approval of parent shareholders if it is a major transaction or a very substantial disposal under the Hong Kong listing rules (meaning it represents at least 25% of the parent based on various financial tests).
Enabling parent shareholders to participate
PN15 requires a Hong Kong listed company doing a spin-off to provide its shareholders with an ‘assured entitlement’ to the shares in the spun-off entity, either by way of a distribution in specie of shares in the entity and / or by way of a preferred application in any offering of shares in the entity, in each case on a pro rata basis (e.g. 4 shares in the entity being spun-off for every 10 shares held in the parent).
The Swire Properties and Global Brands transactions were structured as distributions in specie. This structure avoids the need for an offering and the associated pricing risk, as well as the additional process that this necessitates. However, because no new investment is being obtained, it means that the parent company does not receive any proceeds from the spin-off transaction.
The consequences arising from needing to publicly file the draft listing document
Since October 2013, the initial draft listing document filed with the Stock Exchange is published on the website of the Stock Exchange shortly after it is filed. There are some potential exemptions available for spin-offs, but in practice it is generally difficult to fit within the conditions for these exemptions to apply. A parent preparing for a spin-off therefore needs to consider carefully the timing of that spin-off and what it will announce to the markets when the filing is made. It also means that it is particularly important to clear, so far as possible, the delineation measures and the terms of continuing transactions between the parent and spun-off entity with the Stock Exchange prior to filing, to avoid the risk of needing to amend terms that have already been made public.
As the parent is a continuing listed company, attention has to be paid to publicity concerns and any spin-off involving a distribution in specie will need to focus on the impact of the spin-off in terms of the mechanics of the distribution, including the terms of the timing of the board meeting to approve the distribution, the record date, the book closure and despatch of share certificates in the context of the listing timetable.
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