Introduction

In May 2022, the Stock Exchange of Hong Kong Limited (the “Stock Exchange”) issued two listing decisions concerning listing applicants’ suitability for listing. The first decision is about a listing applicant’s material reliance on another party. The second decision is about the listing applicant’s deterioration of financial performance of its core business, limited track record of its new service and temporary business improvement and failure to prove its business improvement plans. These cases supplement the guidance letter GL68-13 (the “Guidance Letter”), which provides non-exhaustive examples of factors that the Stock Exchange takes into consideration when assessing a new applicant’s suitability for listing pursuant to Rule 8.04 of the Rules Governing the Listing of Securities on the Stock Exchange (the “Listing Rules”).

The Listing Rules and Guidance Letter

Under Rule 8.04 of the Listing Rules, both the issuer and its business must, in the opinion of the Exchange, be suitable for listing.

The Guidance Letter provides that material reliance on another party (e.g. controlling shareholders) may threaten a new applicant’s business sustainability if it is likely that the relationship with such party may materially adversely change. Material reliance may be dealt with by way of disclosure when there are no red flags indicating otherwise that (i) the relationship with other party is unlikely to materially adversely change or terminate; or (ii) the new applicant is/will be able to effectively mitigate its exposure to any material adverse changes/termination of its relationship with the other party.

The Guidance Letter also provides that the Stock Exchange would look into factors such as (a) how susceptible the new applicant’s financial performance is to changes beyond its control; (b) the underlying causes of the deteriorating financial performance and whether such downward trend is expected to continue, or whether it is the cyclical nature of the industry; and (c) whether the new applicant had demonstrated that it is able to effectively mitigate its exposure to the relevant risks or to turn around the business.

The Listing Decisions

Stock Exchange-LD133-2022

In this listing decision, the listing applicant (“Company X”) was founded by Dr A and his wife (the “Founders”). Company X’s only business involved operating two medical specialist clinics. Throughout Company X’s operating history, the Founders generated substantially all of Company X’s revenue with Dr A contributing around 70% to 80% of Company X’s total revenue during the track record period. Company X hired an additional medical specialist (the “New Hire”) in the last year of the track record period but the reliance on Dr A remained significant (over 70% of the Company X’s revenue). Company X proposed to reduce reliance on Dr X by recruiting more medical specialists and operating more clinics within 3 years after listing. The issue is whether Company X is suitable for listing, after taking into account its material reliance on Dr A.

In this case, the Stock Exchange made a ruling that Company X had failed to demonstrate that the material reliance on Dr A could be effectively reduced and the reduction of support from Dr A would not result in a material adverse impact on Company X’s business for the following reasons:

1.       Company X’s business is essentially a medical practice operated by two doctors whose experience, skills, expertise and personal reputation and trust with patients are unique and critical to its success and are non-transferable to other doctors. The failure of the New Hire to generate substantial revenue in the track record period shows that Company X was and would be unable to reduce its reliance on the founders; and

 

2.       No parts of the plans to reduce reliance on Dr A would be materialised before listing. Therefore, the feasibility of the plans could not be proven and was called into question.

Stock Exchange-LD134-2022

In this listing decision, the listing applicant (“Company Y”) owned and operated five hospitals in the People’s Republic of China (the “PRC”) with the majority of its revenue generated by outpatient clinic services and inpatient hospital services (the “Core Businesses”). During its original track record period, the financial performance deteriorated significantly due to the (i) tightening of inpatient admission standards in two hospitals, which acted as preventive measures against further breaches of local regulations by two hospitals; and (ii) scaling down of one hospital (the “Relocated Hospital”) for potential relocation and the reluctance of people visiting hospitals due to the outbreak of COVID-19 pandemic.

 

In Company Y’s renewed listing application, the business and financial performance of the Core Businesses further deteriorated. The Relocated Hospital only managed to achieve 1/3 of its revenue prior to the scale-down of its operation. Two other hospitals which contributed in aggregate to 40% of the total revenue were subjected to imminent relocation risks and Company Y had no specific plans in improving their business. Company Y’s forecast expected that its revenue would further decrease by 10% with no basis to support the growth estimate on its physical examination services and COVID-19 nucleic acid test services. Company Y also failed to prove how its expansion plan and proposed use of proceeds from the listing could improve its business and financial performance.

In this case, the Stock Exchange made a ruling that the sponsor and Company Y had not satisfactorily addressed the Stock Exchange’s concerns on Company Y’s business sustainability and its proposed use of proceeds.

Conclusion

The listing decisions shed light on potential listing applicants that the listing applicant’s business should not materially rely on any party and there should not be any material deterioration of the business performance during the track record period, both factors of which may cast doubt as to the sustainability of its business.

 

For enquiries, please feel free to contact us at:

E: cc@onc.hk                                                                       T: (852) 2810 1212 W: www.onc.hk                                                                    F: (852) 2804 6311 19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2022