In brief

On 27 November 2020, the Stock Exchange of Hong Kong Limited ("Exchange") published a consultation paper ("Consultation Paper") on the minimum profit requirement for a Main Board listing under Rule 8.05(1)(a) of the Listing Rules ("Profit Requirement"). The Exchange proposes to raise the Profit Requirement with a view to improving the overall quality of Main Board issuers and curbing shell creation activities. A temporary conditional relief from the proposed Profit Requirement will also be introduced to facilitate the listing of quality companies whose financial results have been temporarily and adversely affected by the COVID-19 pandemic and the economic downturn. The consultation will close on 1 February 2021.

The proposed Profit Requirement will not only affect new listing applicants but also Main Board-listed issuers in the case of spin-offs or Chapter 14 reverse takeovers, extreme transactions or material disposals, as well as GEM-listed issuers in the case of transfer of listing to the Main Board.


Contents

  1. Background
  2. In more detail
    1. Proposal to increase the Profit Requirement
    2. Temporary relief
    3. Transitional arrangements
    4. Potential impacts on listed issuers

Background

Under the Profit Requirement, a new listing applicant must have the following minimum amount of profit attributable to shareholders: (a) HKD 20 million in the most recent financial year; and (b) HKD 30 million in aggregate in the two preceding financial years. The Profit Requirement has remained unchanged since 1994, while the minimum expected market capitalisation at the time of listing under Rule 8.09(2) has increased from HKD 200 million to HKD 500 million (the "Market Capitalisation Requirement") since 2018.

As a result of the misalignment between the Profit Requirement and the Market Capitalisation Requirement, the Exchange has seen an increase in listing applications from small cap issuers1 that marginally met the Profit Requirement but had significantly higher historical P/E ratios as compared to those of their listed peers. These listing applicants typically justified their valuations by reference to potential growth in their businesses. However, a number of these listing applicants failed to meet their profit forecasts as disclosed in the prospectuses after listing. The Exchange is concerned about whether their valuations were inflated to meet the Market Capitalisation Requirement in order to create potential shell companies for sale after listing.

In more detail

Proposal to increase the Profit Requirement

The Exchange proposes to increase the Profit Requirement by either of the following:

  • Option 1  ̶  150%, based on the percentage increase in the Market Capitalisation Requirement from HKD 200 million to HKD 500 million in 2018. This will increase the minimum amount of profit attributable to shareholders to: (a) HKD 50 million in the most recent financial year; and (b) HKD 75 million in aggregate in the two preceding financial years.
  • Option 2  ̶  200%, based on the approximate percentage increase in the average closing price of the Hang Seng Index from 1994 to 2019.This will increase the minimum amount of profit attributable to shareholders to: (a) HKD 60 million in the most recent financial year; and (b) HKD 90 million in aggregate in the two preceding financial years.

Both Option 1 and Option 2 will result in the Exchange having the highest profit requirement when compared with those of the six overseas main stock markets2 on an aggregated basis for a track record period of three years, and continuing to have the second highest profit requirement for the final year of the track record period (lower than Singapore Exchange Limited).The Exchange aims to further distinguish between issuers listed on GEM and the Main Board and position the Main Board as the main market to attract sizeable companies with high market standards. The Exchange believes that the proposal will therefore improve the overall quality of Main Board issuers.

 

Current Profit Requirement (HKD million)

Proposed Profit Requirement - Option 1 (HKD million)

Proposed Profit Requirement - Option 2 (HKD million)

In aggregate for the first two financial years

30

75

90

For the most recent financial year

20

50

60

Total

50

125

150

Implied historical P/E ratio

(assuming both the Profit Requirement and the Market Capitalisation Requirement are marginally met)

25 times

10 times

8 times

 

Temporary relief

To facilitate the listing of quality companies whose financial results have been temporarily and adversely impacted by the negative market conditions in 2020, the Exchange may consider granting a temporary relief from the profit spread in the proposed Profit Requirement on a case-by-case basis. A listing applicant seeking such relief will be required to submit an application to the Exchange demonstrating that it is able to meet the following conditions:

  • Its aggregate profit during the track record period meets the aggregate profit threshold, i.e., HKD 125 million under Option 1 or HKD 150 million under Option 2.
  • It had a positive cash flow generated from operating activities in the ordinary and usual course of business before changes in working capital and taxes paid in the most recent financial year.
  • It demonstrates that the conditions and circumstances leading to its inability to meet the profit spread in the Profit Requirement are temporary.
  • The track record period must have at least six consecutive months that fall within the calendar year 2020.
  • Adequate disclosure is made in its listing document.

Transitional arrangements

Main Board listing applications (including applications for transfer of listing from GEM to the Main Board3) will be assessed under the current Profit Requirement if they are submitted before the Rule Amendment Effective Date (proposed to be on or after 1 July 2021) and remain active4 as of the Rule Amendment Effective Date. Such application will be allowed to be renewed5 once after the Rule Amendment Effective Date for continued assessment under the current Profit Requirement. For any subsequent renewals, the application will be assessed under the increased Profit Requirement.

Potential impacts on listed issuers

The proposed Profit Requirement will not only affect new listing applicants but also Main Board-listed issuers in the case of spin-offs or Chapter 14 reverse takeovers, extreme transactions or material disposals, as well as GEM-listed issuers in the case of transfers of listings to the Main Board. 

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