Backdoor listings and small free float IPOs and alternate exit mechanisms

We recently acted for Chemist Warehouse in its transaction with Sigma, a novel alternative to an IPO. In an environment containing a tempered IPO market and uncertainty over secondary sale processes due to the cost of debt funding, alternative exit mechanisms may prove an attractive option for sponsors. We consider exits through backdoor listings and IPOs with a low free float as two potential alternatives. 

Backdoor listings 

A backdoor listing involves a listed company acquiring an unlisted company or assets, thereby allowing the unlisted company (or the business conducted by the unlisted company) to become listed. In the case of a backdoor listing, the acquisition consideration is ordinarily scrip and the unlisted company is larger than the listed acquirer in operational and financial terms, with the result that the merged group will be predominantly comprised of the unlisted company’s operations. The merged group will also be owned primarily by the unlisted company’s former shareholders.

The backdoor listing method enables the unlisted company and its owners to access public capital markets without a formal IPO, although ASX will ordinarily require the merged group to re-comply with its admission requirements, including through issue of a prospectus. A fresh set of investors may not need to be sourced and the listed acquirer’s shareholder base will assist in meeting the ASX’s minimum spread requirements. 

A backdoor listing also gives shareholders of the unlisted company access to liquidity, enabling them to fully or partially divest their holding over time (although strategically important shareholders, such as founders or sponsors, may be subject to escrow requirements for a period of time). 

The listed acquirer will be required to obtain shareholder approval itself, including for a significant change to the nature or scale of its activities (ASX Listing Rule 11.1.2). Shareholder approval may also be required for the issue of shares as consideration if more than 15% of the listed acquirer’s capital will be issued (ASX Listing Rule 7.1).

A compelling example of a recently proposed transaction with some of the above features is the Chemist Warehouse and Sigma transaction.

Chemist Warehouse and Sigma

The Chemist Warehouse and Sigma merger was announced on 11 December 2023. Sigma, an ASX listed company, agreed to acquire all Chemist Warehouse shares via a scheme of arrangement (as Chemist Warehouse is an unlisted public company with around 200 shareholders). In return, Chemist Warehouse shareholders will receive cash and shares in Sigma. 

Chemist Warehouse is significantly larger than Sigma, with Chemist Warehouse generating $555 million of EBITDA for the 12 months to 30 June 2023 while Sigma generated $66 million for the 12 months to 31 July 2023. Chemist Warehouse shareholders will hold 85.75% of the merged group while Sigma shareholders will hold 14.25%. 

The transaction will provide a liquidity event for Chemist Warehouse shareholders who will receive cash as well as scrip for their shares (as well as opening the door for future sell downs) and allow the Chemist Warehouse business to make a long-awaited foray onto the ASX. At an operating business level, the merger will create a full service wholesaler, distributor and retail pharmacy franchisor. 

The Chemist Warehouse – Sigma transaction structure may be adopted by sponsors as a method of exiting a portfolio company, subject to two qualifications. 

• First, this form of transaction is most beneficial if a complementary listed acquirer for the portfolio business can be sourced, which will provide verifiable benefits or synergies from the merger. This will assist in garnering the support of the acquirer’s shareholders. This also provides a commercial logic to the transaction compared to undertaking an IPO. 
• Second, unless there is some form of cash consideration, a backdoor listing may not be an immediate method of exit for the sponsor, and there is a risk of a large sponsor shareholding creating an ‘overhang’ effect on the listed company’s share price.

It is also important to keep in mind that backdoor listing transactions may involve substantial complexity. For example, while Sigma is not required to re-comply with the ASX’s admission requirements (which is unusual in itself and reflects the fact the transaction is a merger between two entities of substance), it must comply with specific disclosure obligations and lodge a re-listing prospectus in respect of the merged group. This, together with the scheme booklet and notice of meeting for the Sigma shareholder meeting, creates a suite of required disclosure documents. Multiple independent expert’s reports will also be needed for this transaction. Parties wishing to consider this alternative will therefore need to carefully step through the legal requirements. 

Small free float IPOs

An alternative to a traditional IPO is for a sponsor to launch an IPO with a smaller raise size and free float. ‘Free float’ refers to the percentage of securities that are not restricted or subject to escrow arrangements and are held by non-company affiliated securityholders. A smaller raise and free float reduces the need to source a large number of investors for the listing, addressing the difficulties with recent IPO markets. 

The sponsor will need to retain a substantial stake in the listed vehicle, meaning that their exit is weighted towards more significant block trades rather than a large initial selldown. Staggered sell downs may also enable sponsors to periodically reduce their leverage to palatable levels. Other shareholders, including key management personnel and executives, may be required to enter into escrow arrangements. These arrangements may be beneficial for the listed business’ post-IPO operations, as they will assist with a smooth transition and signal ongoing commitment to the business (which may be important to strengthen investor interest). 

There will be limits to this option as the ASX requires a minimum free float of 20% for listing. Although a scarce supply may assist the price in the short term, a smaller free float will reduce the liquidity of the listed securities. This in turn may create issues around price discovery and volatile price movements from the limited trades that do occur. A significant overhang in the shares will also mean that a sponsor is subject to a greater degree of market risk compared to a large initial selldown. 

While there are countervailing factors to consider in seeking a listing with a small free float, this nonetheless presents an interesting alternative in current market conditions. We have seen sponsors successfully take this approach and realise high prices in subsequent block trades. For example: 

• In the Ventia IPO, Apollo initially sold 6.29% of its stake at $1.70. Apollo subsequently sold down the rest of its stake in block trades at prices between $2.15 to $2.71.  
• In the Veda IPO, PEP did not sell down initially at the IPO issue price of $1.25. PEP subsequently sold down its stake in block trades at prices between $2.15 to $2.31.