On 27 November 2020, the Stock Exchange of Hong Kong Limited published a consultation paper on the minimum profit requirement for a Main Board listing under rule 8.05(1)(a) of the Listing Rules. 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 with financial results that have been temporarily and adversely affected by the covid-19 pandemic and the economic downturn. The consultation closes 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; and Growth Enterprise Market-listed (GEM) issuers, in the case of transfer of listing to the Main Board.
Under the profit requirement, a new listing applicant must have the following minimum amount of profit attributable to shareholders: (1) HK$20 million (US$2.5 million) in the most recent financial year; and (2) HK$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 HK$200 million to HK$500 million (the market capitalisation requirement”) since 2018.
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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 issuers that marginally met the profit requirement but had significantly higher historical price-to-earnings ratios 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.
Proposal details
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 HK$200 million to HK$ 500 million in 2018. This will increase the minimum amount of profit attributable to shareholders to: (a) HK$50 million in the most recent financial year; and (b) HK$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) HK$60 million in the most recent financial year; and (b) HK$90 million in aggregate in the two preceding financial years.
Both options 1 and 2 will result in the exchange having the highest profit requirement when compared with those of the six overseas main stock markets on an aggregated basis for a track record period of three years, and continuing to have the second-highest profit requirement for the final year of the track record period (lower than Singapore Exchange Limited).The exchange aims to further distinguish between issuers listed on the GEM and the Main Board, and position the Main Board as the main market to attract sizeable companies with high market standards. The exchange believes that the proposal will therefore improve the overall quality of Main Board issuers.
| Current Profit Requirement (HK$ million) | Proposed Profit Requirement – Option 1 (HK$ million) | Proposed Profit Requirement – Option 2 (HK$ 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 with financial results that have been temporarily and adversely impacted by the negative market conditions in 2020, the exchange may consider granting 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:
(1) Its aggregate profit during the track record period meets the aggregate profit threshold, i.e., HK$125 million under option 1 or HK$150 million under option 2;
(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;
(3) It demonstrates that the conditions and circumstances leading to its inability to meet the profit spread in the profit requirement are temporary;
(4) The track record period must have at least six consecutive months that fall within the calendar year 2020; and
(5) Adequate disclosure is made in its listing document.
Transitional arrangements
Main Board listing applications (including applications for transfer of listing from the GEM to the Main Board) 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 active as of the rule amendment effective date. Such applications will be allowed to be renewed 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.
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.
Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker McKenzie by e-mailing Howard Wu (Shanghai) at howard.wu@bakermckenzie.com
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