Reverse Mergers

Computerworld - It sounds like a match made in heaven. A small, private firm that's hungry for capital and eager to go public hooks up with a public company with no assets or operations to speak of but desperate to create some value for unhappy shareholders.

If the private firm acquires the shell of the defunct public company, voila - it can become a public company almost overnight.

It's much cheaper, easier and faster (two to four months, compared with about a year) than issuing a prospectus and landing an underwriter to file an IPO, which involves registration statements that require detailed disclosures.

That's how Ted Turner launched Atlanta-based Turner Broadcasting System Inc. in the mid-1970s. During the past few years, reverse mergers, popular in the early 1980s and mid-1990s, have enjoyed a comeback, particularly among technology and Internet firms that were eager to cash in on the IPO bonanza before the stock market began heading south last year.

Happily ever after? Not necessarily. The shell company that's acquired may be no bargain if it's saddled with debts, liens or lawsuits. Shareholders may sell their shares to cash in soon after the deal is completed, thereby sinking the stock. Creditors may also appear, demanding payment.

An unsavory reputation also haunts reverse mergers. Shady stock promoters often hype the stocks, then sell them off in what are referred to as "pump-and-dump" schemes.

Because of the many fraud cases, the Securities and Exchange Commission (SEC), which takes a dim view of reverse mergers as a backdoor route to going public, toughened its policies on them in the mid-1990s and again last year. Many financial experts also say they tend to suspect the motives of firms involved in reverse mergers.

"I certainly always looked with a jaundiced eye at them, since they didn't undergo the scrutiny other companies did that went public in the usual way. And the past history has not been good," says Charles Hill, director of research at First Call/Thomson Financial, a financial research firm in Boston. "A perfectly legitimate company may feel it's a good way to do it, but it's a tougher row to hoe in getting attention from reputable analysts."

Reverse mergers have certainly produced some odd couples. For example, Piranha Inc., a Richardson, Texas-based maker of digital compression products for streaming video and prepress publishing, merged with a public company, Chicago-based comic book and games retailer Classics International Entertainment Inc., in 1999.

Piranha managed to acquire three small firms after the reverse merger with Classics International, which stopped operating in the 1990s and whose stock reached its nadir at a half-cent per share in early 1998 on the "pink sheets." The lowest regulatory rung of all stocks, pink sheets refer to stocks that aren't listed on any exchange or Nasdaq, although quotes are provided to traders.