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LD116-2017

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HKEX LISTING DECISION
HKEX-LD116-2017 (published in November 2017)

Party Company A — a Main Board issuer
Issue Whether Company A had a sufficient level of operations or sufficient assets to meet Main Board Rule 13.24
Listing Rules Main Board Rules 6.01(3) and 13.24, and Practice Note 17 to the Main Board Rules
Decision Company A had failed to maintain a sufficient level of operations or sufficient assets to meet Main Board Rule 13.24, resulting in commencement of delisting procedures under Practice Note 17 to the Main Board Rules

FACTS

1. Company A and its subsidiaries (Group) were principally engaged in the manufacturing and sale of fashion accessories (Fashion Accessories Business) and the development and sale of software related applications (Software Business).
2. Over the past few years, the Group had gradually scaled down the Fashion Accessories Business by disposing of its manufacturing arms, outsourcing such function to other subcontractors, and closing its retails shops. Revenues from this business segment decreased from about HK$200 million to HK$9 million during the last five financial years. Company A had decided to discontinue this business, and the revenue of HK$9 million in the latest financial year was mostly generated from the sale of obsolete inventories.
3. The Group started the Software Business through its acquisition of a company (Acquisition) engaging in such business at a consideration of HK$160 million about a year ago. It was noted that:
(a) In the latest financial year, the Group recorded revenue of around HK$6 million from this business and an impairment loss of HK$9 million on goodwill arising from the Acquisition. As at the year end date, the goodwill amounted to HK$140 million.
(b) The Group's auditor had issued a disclaimer opinion on the Group's financial statements due to, among others, issues concerning the revenue recorded from the Software Business and the carrying value of the goodwill. In particular, the auditor had raised concern about the carrying value and recoverability of the goodwill having considered the short history of the Software Business, the difficulties faced by the management in executing the business plan and the lack of supporting information relating to the revenue from this business.
(c) Towards the end of the latest financial year, all the staff for the development team of the Software Business left their employment, resulting in suspension of its operation. The operation resumed only after new staff were recruited three months later.
4. As at the latest year end date, the Group had total assets of HK$280 million.
(a) Its major assets included (i) goodwill of HK$140 million in relation to the Software Business (see paragraph 3 above); and (ii) a deposit of HK$31 million paid for the acquisition of certain trademarks relating to the Fashion Accessories Business under an agreement signed two years ago. The title of the trademarks had not been transferred to the Group and there was insufficient evidence to satisfy the auditors as to the recoverability of such deposit.
(b) Other assets mainly included cash, trade and other receivables and prepayments.
5. The Group had recorded net losses and negative operating cashflows for each of the last five financial years.
6. The Exchange queried whether Company A was maintaining sufficient operations or assets as required under Main Board Rule 13.24.
7. Company A submitted that it had plans to improve its business operations.
(a) The Group had entered into sales contracts of about HK$16 million for the Software Business and was in discussion with potential customers on new contracts of HK$6 million. Company A expected a significant increase in revenues from this business to HK$23 million and HK$35 million in the current and the next financial year respectively, but did not provide details or basis for its business plans or forecasts.
(b) The Group also planned to commence certain regulated activities under the Securities and Futures Ordinance (the Securities Business). It expected to obtain the relevant licenses within 3 months and record revenue of about HK$2.5 million from this business in the next financial year.
(c) Based on the above, Company A expected that the Group would record net profits of about HK$2 million and HK$16 million in the current and next financial year respectively.

APPLICABLE LISTING RULES AND GUIDANCE MATERIALS

8. Main Board Rule 2.03 states that—

"The Listing Rules reflect currently acceptable standards in the market place and are designed to ensure that investors have and can maintain confidence in the market and . . ."
9. Main Board Rule 13.24 states that—

"An issuer shall carry out, directly or indirectly, a sufficient level of operations or have tangible assets of sufficient value and/or intangible assets for which a sufficient potential value can be demonstrated to the Exchange to warrant the continued listing of the issuer's securities."
10. Main Board Rule 6.01 states that—

"Listing is always granted subject to the condition that where the Exchange considers it necessary for the protection of the investor or the maintenance of an orderly market, it may at any time direct a trading halt or suspend dealings in any securities or cancel the listing of any securities in such circumstances and subject to such conditions as it thinks fit, whether requested by the issuer or not. The Exchange may also do so where:—

. . .
(3) the Exchange considers that the issuer does not have a sufficient level of operations or sufficient assets to warrant the continued listing of the issuer's securities (see rule 13.24). . ."
11. Listing Decisions (LD35-2012 and LD88-2015) describe the purpose behind Main Board Rule 13.24 and provide guidance on the application of the Rule:

". . .Rule 13.24 is intended to maintain overall market quality. Issuers that fail to meet this Rule are "blue sky companies" where public investors have no information about their business plans and prospects. This leaves much room for the market to speculate on their possible acquisitions in the future. To allow these issuers' shares to continue to trade and list may have an adverse impact on investor confidence.

. . .

When applying Rule 13.24 to issuers whose shares are trading on the Exchange, the Exchange generally allows their shares to continue to trade as long as they have an operation and meet the continuing disclosure obligations. If the Exchange were to suspend these issuers because of their low level of activities or assets values, public shareholders would have no access to the market for trading the issuers' shares. To balance the public shareholders' interests with the need to maintain market quality, the Exchange suspends trading only in extreme cases.

. . ."

ANALYSIS

12. Main Board Rule 13.24 requires issuers to maintain a sufficient level of operations or assets of sufficient value to warrant the continued listing of their securities. Without quantitative criteria for sufficiency, this Rule calls for a qualitative test and is assessed based on the specific facts and circumstances of individual cases.
13. An issuer that fails to meet Rule 13.24 is a "blue sky company" that would attract speculation on its possible acquisitions in the future and lead to opportunities for market manipulation, insider trading and unnecessary volatility in the market which are not in the interest of the investing public. As set out in paragraph 11 above, to balance public shareholders' ability to access the market to trade in the security with the need to maintain market quality, the Exchange would suspend trading only in an extreme case. When making the assessment, the Exchange takes into account the current regulatory concerns and the acceptable standards in the market.
14. In recent period, the Exchange has tightened its approach in applying Rule 13.24 by treating cases with the following characteristics as extreme cases:—
(a) a very low level of operating activities and revenue; for example the issuer's business does not generate sufficient revenue to cover its corporate expenses, resulting in net losses and negative operating cashflows;
(b) the current operation does not represent a temporary downturn, the issuer had been operating at a very small scale and incurring losses for years; and
(c) the assets do not generate sufficient revenue and profits to support a continued listing.
In these cases, the issuers are not operating substantive businesses, and the value of the businesses (excluding the listing status) is minimal, if any. There is a question whether the Rule requirement to carry on a sufficient level of operations or have assets of sufficient value is met. The Exchange considers it necessary to apply Rule 13.24 in these cases with a view to maintaining investors' confidence and overall market quality.
15. Once suspended, the issuer would be given a remedial period to submit a resumption proposal to demonstrate that it has a viable and sustainable business to re-comply with Rule 13.24. If the issuer fails to do so, it would be delisted according to the delisting procedures under Practice Note 17 to the Rules.
16. In this case, the Exchange considered that Company A had failed to comply with Rule 13.24 and this was an extreme case:
(a) The Group had a very low level of operations. Its original business (the Fashion Accessories Business) had diminished substantially, causing the Group to record losses and negative operating cashflows in each of the last five years. This business generated revenue of HK$9 million only in the latest financial year, which was mostly generated from a one-off sale of obsolete inventories. Company A had decided to discontinue this business.
(b) The Group sought to rely on new businesses (the Software Business and the Securities Business) to support its listing. However,
-   The Software Business had a short operating history. It generated minimal revenue of HK$6 million in the latest financial year, which was insufficient to cover the corporate expenses of the Group.
-   Company A expected to record total revenue of HK$58 million from the Software Business in the current and next financial years, of which the Group had entered into sale contacts of HK$16 million only. Company A had not provided any details of its business plans to support a substantial increase in the scale of operations of the Software Business as projected.
-   The Securities Business was still in at the planning stage and had not commenced operations. Based on Company A's projection, even if the business would proceed to operate as planned, it would generate revenue of HK$2.5 million only in the next financial year.
(c) In light of the above, Company A had failed to demonstrate that it had a viable and sustainable business to support its listing status.
(d) Company A had also failed to demonstrate that it had assets of sufficient value to support its listing status. The Group's auditors had raised concerns about the recoverability of the goodwill relating to the Software Business and the deposit paid for acquisition of trademarks, which accounted for a majority of the Group's assets. Also, the operations of the Group's assets had not generated sufficient revenue and profits to ensure Company A to operate a viable and sustainable business.

CONCLUSION

17. The Exchange decided that Company A had failed to maintain a sufficient level of operations or assets of sufficient value to meet Rule 13.24. This resulted in commencement of delisting procedures under Practice Note 17 to the Rules.