This article was first published on China Business Law Journal , authorised reprint.
A spin-off usually refers to the separation of one or more business segments from an existing listed company, aiming to effect an independent listing of the separated segments, either as a new listed company or through another existing listed company.
Spin-offs can achieve several important business and financial objectives, including:
•Increasing shareholder value when the separately listed company achieves higher valuation;
•Facilitating investors’ evaluation and targeted investment decision-making in the delineated business and the risk characteristics of each listed company;
•Boosting performance of each listed company by enabling the respective management teams to focus on their distinct core businesses; and
•Offering the separated companies flexibility to pursue capital allocation strategies that suit their individual business needs and priorities.
From the perspective of an existing (parent) listed company, a spin-off might not only streamline its operation, it might also release it from bearing the full operating cost of the entities (newcos) that are to be spun-off.
Depending on the structure of the spin-off, the parent company may enjoy the economic benefits of the growth of the newco after obtaining additional capital from the spin-off, while maintaining its control over the newco, resulting in a strong balance sheet and financial performance.
HONG KONG RULES
A newco must satisfy all requirements of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited for new listing applicants. In addition, practice note 15 of the listing rules (PN15), particularly, sets out the policy of the Hong Kong Stock Exchange (HKEX) with regard to proposals submitted by HK listed companies to effect a separate listing on the HKEX or elsewhere of assets or businesses wholly or partly within their existing groups.
DIFFERENT TO IPO
The following table shows the key differences in listing rules between a spin-off listing and an initial public offering in a general situation.
SPIN-OFF CONCERNS
In the following section, this article looks at some key concerns from regulators during spin-off applications and listing application filed by newcos.
No one asset/two listing. The parent must retain sufficient assets and operations to support its separate listing status. Normally, the listing committee would not accept one business (the newco’s) to support two listing status (the parent and the newco). In short, the parent is required to retain, in addition to its interest in the newco, sufficient assets and operations of its own, excluding its interest in the newco, to satisfy independently the requirements of chapter 8 of the listing rules.
Independence. The listing rules require that newcos must be capable of carrying on their business independently of their parents in operational, management and financial aspects. The HKEX does not accept significant overlap between the directors and senior management of a newco and its parent. The newco should have a sufficient number of executive directors who have no conflict of interest to run the business of the newco, and who will not consider the interests of the controlling shareholder alone. In addition, demonstration of the newco’s independence may be affected by significant continuing connected transactions contemplated after the spin-off or the parent’s financial assistance to the newco in the form of, for example, shareholders’ loans, guarantee or pledge of its assets.
Competition. The parent should try its best to avoid retaining any business that may compete or is likely to compete with the business of the newco. The HKEX requires clear business delineation between a parent and its newco, and may consider various factors to determine if there is clean delineation, such as geographic region of the business, target customers and business model, as well as other protections like strong corporate governance measures in managing conflict of interests, or provision of non-compete undertakings by the parent.
Assured entitlement. PN15 provides a parent to have due regard to the interests of its existing shareholders by providing them with an assured entitlement to shares in a spin-off newco. This could be done either by way of a distribution in specie of existing shares in the newco or by way of preferred application in any offering of existing or new shares in newco.
In a typical case of distribution in specie, a newco will issue new shares to the existing shareholders of its parent on a pro rata basis, either directly or through the parent. Where the assured entitlement is provided by way of preferential subscription, the newco will give the existing shareholders of the parent a preferential right to subscribe to the shares of the newco in the IPO. Where the parent decides not to provide, or cannot provide due to practical difficulties the assured entitlement to its shareholders, it must obtain approval from its shareholders, or seek a waiver from the listing committee.
Other concerns. In normal circumstances, the HKEX will not consider a spin-off proposal within three years of a company’s listing.
In a spin-off involving a distribution in specie, the mechanics of distribution shall be designed carefully, which includes the terms of the distribution, the timing of the board meeting to approve the distribution, the record date, the book closure and dispatch of share certificates in the context of the listing timetable.
Finally, in both spin-off and IPO, any agreements binding on the parents/shareholders of the proposed listing company, and any consents or restrictions or veto rights relating to the disposal of material assets or businesses that are relevant need to be assessed and dealt with.
SPIN-OFF VERSUS IPO
|
Requirements |
Spin-off |
IPO |
|
Filing an application under PN15 by the parent and obtaining approval from the HKEX listing committee |
A PN15 application must be made and the approval of HKEX must be obtained before the newco files its listing application. |
No such requirement |
|
Shareholders approval |
A spin-off transaction also requires the approval of the parent’s shareholders if it constitutes a major transaction or a very substantial disposal under the listing rules (i.e. represents at least 25% of the parent based on various ratio tests). |
Subject to the articles of the proposed listing company only |
|
Assured entitlement |
PN15 requires the parent to provide its shareholders with an assured entitlement to shares in the newco, by way of either a distribution in specie of shares in the newco or preferential application in the offering of shares in the newco. |
No such requirement |
|
Parent’s regulatory procedures |
The parent has to pay attention to any additional requirements under the listing rules for a listed company as a result of the spin-off. For example, the parent should assess if any continuing transactions between the parent and newco may constitute continuing connected transactions subject to the requirements under chapter 14A of the listing rules after spin-off. The parent should also assess if the spin-off will constitute price-sensitive information, in particular where the spun-off business represents a material segment of the parent, and publish an announcement at an appropriate time. |
As the shareholders of the proposed listing company are not listed on the HKEX, the listing rules do not apply directly |
CONCLUSION
Spin-offs and listings are relatively mature in the Hong Kong stock market. A spin-off provides an effective means for a listed company to manage its capital resources and raise new capital for its own business development.
In recent years, numerous Hong Kong listed companies have successfully spun-off part of their businesses and launched separate listings. Among these, a significant proportion have been spin-offs of property management from property developer companies.
In 2023, following the announcement of spin-off plans by two e-commerce giants, Alibaba and JD.com, we saw interest in spin-offs in more diversified industries. From 2022 to 2023, more than 40 Hong Kong listed companies, from technology, biopharmaceutical, finance, real estate, manufacturing, consumer goods and energy industries, announced their intention to spin-off and launch a new listing on Hong Kong or PRC domestic securities market.
