Clock ticking for AIM cash shells

Luke Ahern, director of broking at Corporate Synergy Plc, urges investors to be alert to the consequences of a crackdown by Stock Exchange regulators on the glut of shell companies which have joined AIM.

Firms from the UK, Europe and the rest of the world have been flocking to list their shares on AIM. No wonder the 10th anniversary awards ceremony in London was recently such a success. So far this year £4.9 billion has been raised and 389 companies have been admitted including 78 from overseas. Since its inception more than 2,700 have joined – many opting to step down from the main market.

Every day another company joins the queue - this year has seen wine growers from Australia, a chemical company from Israel, copper miners from Zambia and the Congo, a hotel developer in Dubai…the list is endless.

What is the main attraction of AIM? It is relatively cheap and easy to raise money yet retains a light regulatory touch that still protects investors while its favourable capital gains tax treatment and inheritance tax relief only adds to its appeal.

However, there has been some recent slackening in the number of companies joining AIM which can be traced back to changes to the listing procedures announced by the Stock Exchange in March. Anxious to safeguard the junior market's reputation the authorities have become concerned at the glut of ‘shell’ companies being admitted.

Shells are companies which are listed on the stock market but not actively trading. Some are characterised by having no, or very few, assets beyond the name of their backers and some cash in the bank.

But concerns have been increasing over the broad brush business plans being produced by these ventures – a typical example might be they want to take advantage of 'international opportunities in natural resources' – which give few clues to their intentions and how they plan to spend investors’ money.

One company – headed by an internationally known financier – said it was interested in investing ‘in either one or more quoted or unquoted businesses’ in the ‘English speaking world’. So that tells you a lot about it then.

The Stock Exchange decided reform was necessary, on the grounds that the primary business of an 'investing company commonly known as a cash shell' was 'investing its funds in shares of other companies or buying businesses.'

So last March it ruled that cash shells must now raise a minimum of £3 million. The hope is that increasing the size of the shell would require proper support from institutions thereby ensuring an extra level of scrutiny of the investment strategy of the company and the directors’ experience.

If, after 12 months, there has been no acquisition then shareholders will be given the opportunity to vote on whether the cash shell should continue. They will have to vote every 12 months until a deal is done. But cash shells that were on the market before last April and raised less than £1 million will have to do a deal before next April or face eviction.

So the clock is ticking towards the April 2006 deadline putting more pressure on the companies and their backers to come up with deals. With good deals usually at a premium, we can reasonably predict a frenzy of corporate activity over the next few months as shells rush to complete transactions before the drawbridge is raised.

For directors of AIM shells, there will be clear challenges, the foremost of which is avoiding convenient deals simply because they are readily available. There is no excuse for not doing the usual careful due diligence, even with time marching on.

Another challenge for directors is to ensure that advisers will be fleet of foot and ready to move quickly, should a potential deal need to be done quickly. I would recommend that directors of shells keep close and regular contact with their advisers, so that everyone is primed and ready when the deal needs to be transacted.

And with an estimated 88 shells sitting on something like £80 million of cash, it will be the most efficiently-organised management and advisory teams that will be first to take advantage of the best opportunities.

These are not only challenges for directors. There are also clear concerns here for investors who stumped up the original capital. They will be keen to see cash preserved, saving the fire power for when the transaction needs to be made. They will be less than happy if they see directors paying themselves generous salaries or racking up large expenses with consultants as they sift through prospective acquisitions.

Another consequence of doing a deal too near to next April is that any premium in the value of the share price to the underlying assets – i.e. cash – could begin to fall as the deadline approaches and the likelihood of a deal diminishes.

The usual method for a shell to turn itself into a fully-fledged operating business is through a reverse takeover. This is where it uses its shares to buy an unquoted company which has a viable business run by someone who wants to make it bigger and more successful by becoming a public company.

Some entrepreneurs are behind more than one shell - one former house builder turned wheeler dealer has four at the moment - and they often have backing from the same fan club or group of professional investors.

Often these investors know the risks and are prepared to accept them. But there are real concerns for people who bought into, say, a shell set up to invest in a leisure company only to find the directors are now sinking the cash into a zinc mine in China. They are right to wonder whether the original board has the expertise to change direction so dramatically.

As we draw closer to the cut-off date for shells to complete transactions, investors need to be on their guard that the deals being undertaken with their money have been properly researched and the people who will run the ventures have the right credentials.

Equally, the nearer it gets to April, directors need to be mindful that their options are lessening by the month, including their ability to turn a shell into a fully-fledged operating business through a reverse takeover.

With so much activity due, directors of shells should question whether their advisors are up to the task and have the requisite deal flow and strong market contacts. If not, they shouldn’t hesitate to find advisers that do as we approach crunch time.