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Reserve Bank of Australia Bulletin October 2002
Dual-listed Companies
Introduction
Last year, two Australian companies (BHP and Brambles) used a dual-listed company (DLC) structure to facilitate their international expansion. They joined CRA, which had entered into a similar arrangement with RTZ to form Rio Tinto in the mid 1990s.
DLC structures remain quite unusual in the international context, with only a few in existence in the major countries today. They involve a company linking with a foreign company in a way that allows each to retain its individual identity, but with the shareholders of the two separate companies receiving a claim on the combined earnings as though they had undertaken a conventional merger.
DLCs are an interesting phenomenon because even though in theory the share prices of the two companies, measured in a common currency, should be identical (since they represent identical claims on the future cash flows of the group) in practice substantial divergences in prices are observed. This raises the question of why different markets value the same cash flows differently.This note looks at this issue in relation to the experience of
the three Australian companies involved in such structures.
What are DLCs?
DLC structures are effectively mergers between two companies in which the companies agree to combine their operations and cash flows, but retain separate shareholder registries and identities. In this respect, a dual listing is quite different to a cross listing. Whereas a dual listing involves the (quasi) merger of two separate entities, a cross listing occurs when an individual company establishes a secondary listing on a foreign exchange, the most prominent arrangement being via American Depositary Receipts (ADRs). One for m of DLC involves the two companies transferring their assets to one or more jointly owned subsidiary holding companies. The holding company then passes dividends back to the main companies, which distribute them to shareholders according to a predetermined ratio.^2 Alternatively, instead of the transfer of assets, there may be contractual arrangements
- This article was prepared by Jaideep Bedi and Paul Tennant, International Department.
- Further details of the different legal structures are given by Hancock, Phillips and Gray (1999).
October 2002 Dual-listed Companies
to share the cash flows from each other’s assets. This framework has been adopted in the Rio Tinto, BHP Billiton, and Brambles DLCs. Under this arrangement, the individual companies retain their separate assets but align their operations by having either a single board of directors or identical boards elected through a joint voting mechanism. The companies pay equal dividends to their shareholders, and shareholders have equivalent votes in the decisions regarding the two companies, in line with the relative ‘weights’ of the two companies established at the time of the creation of the DLC. In the event that one company does not have sufficient earnings to pay the agreed dividend to its shareholders, there are arrangements for an equalisation payment from the other company.^3
Although the two companies in the DLC provide investors with exactly the same dividend streams, they are traded in different markets and different currencies, and their shares cannot be exchanged for each other. Hence, in the DLC case there is no avenue for pure riskless arbitrage to ensure that the price of equivalent cash flows and voting rights in the two companies should be exactly the same. The difference between the two valuations (expressed in a common currency) is referred to as the premium or discount between the companies. There are several examples where the prices of DLC twins have diverged significantly.
Why do Companies Choose
DLC Structures?
In practice, it appears that all DLCs have been the result of mergers between companies domiciled in different countries. The inter national experience suggests that
companies may choose DLC structures rather than conventional mergers for a number of reasons:^4
- Tax or accounting factors. A DLC structure may avoid capital gains tax obligations that would result from a conventional merger. Alternatively, differences in national tax systems may favour a DLC structure whereby cross-border dividend payments to shareholders are minimised. Similarly, accounting regimes may favour a DLC over a conventional merger or acquisition if the latter would require recognising and amortising goodwill that results from the merger.
- National identity issues and foreign investment regimes. A conventional merger or takeover would result in the disappearance of one of the companies. Since complicated cross-border mergers typically require various forms of official approval, DLCs that preserve the existence of each company in each market may be the best way of ensuring that approval. In addition, in cases where the two companies are of similar size, the companies may both wish to avoid the appearance of having been taken over.
- Operational and corporate governance issues. The existing contractual arrangements of the companies may cause various types of rights to be triggered (e.g., options in debt contracts, rights of other companies involved in joint ventures) in the event of a takeover or conventional merger. However, these consequences may be avoided if the merger occurs in the form of a DLC arrangement.
- Perceptions of better access to capital markets. Since local investors are already familiar with their respective companies, management may believe that the merged company will have better access to capital
- A third type of structure involves shareholders in each company receiving an equity unit that consists of a share in each company. This type of structure was used in the case of the Anglo-Irish Wedgwood/Waterford merger, and in the creation of the Anglo/French EuroTunnel enterprise. In these cases the equity units cannot be split, so that – unlike the other cases discussed in this article – the shares of the two companies do not trade as separate securities.
- See Hancock, Phillips and Gray (1999), Glanz and Sanderson (2001) and Smith and Cugati (2001) for further discussion of DLCs, and their advantages and disadvantages relative to conventional mergers.
October 2002 Dual-listed Companies
cases like Royal Dutch Petroleum/Shell and Unilever NV/PLC, price differences of up to 30 per cent and large swings within one or two years have not been uncommon. Researchers have been unable to identify fundamental factors that provide a convincing explanation for the existence of such large and variable price differences between DLC twins.
One interesting finding by Froot and Dabora (1999) is that although the level of the premium or discount between twins may be hard to explain, it is possible to explain some of the changes in the price difference. In examining the cases of Royal Dutch Petroleum/Shell, Unilever NV/PLC, and SmithKline Beecham, Froot and Dabora find that prices of individual twins showed ‘excess comovement’ with the local stock market index in the country where most of the twins’ trading occurs. For example, the price of Royal Dutch was affected relatively more by developments in the US stock market (where
it traded most actively, in the form of an ADR) while the price of Shell was influenced relatively more by movements in the UK stock market (where it traded most actively). Hence changes in the premium or discount between twins were partly explained by relative movements in the relevant national stock market indices. This finding has been widely interpreted as evidence that asset prices are partly determined by the sentiment in the markets where trading occurs. Although it is hard to explain why different markets should attach different valuations to the same set of cash flows, there are other related examples of apparently anomalous asset pricing. For example, closed-end mutual funds or listed investment trust funds frequently trade at premia or discounts to their net asset value. A factor that is common to both the DLC and closed-end fund cases is that it is not possible to undertake pure arbitrage trading to take advantage of such
Table 1: Dual-listed Companies
Company Country Period of DLC
Rio Tinto Limited Australia Since Dec 1995 Rio Tinto PLC UK BHP Billiton Limited Australia Since Jun 2001 BHP Billiton PLC UK Brambles Industries Limited Australia Since Aug 2001 Brambles Industries PLC UK Shell Transport & Trading Co PLC UK Since 1903 Royal Dutch Petroleum Netherlands Unilever PLC UK Since 1930 Unilever NV Netherlands Reed Elsevier PLC UK Since Jan 1993 Reed Elsevier NV Netherlands ABB AB Sweden Jan 1988 – Jul 1999 ABB AG Switzerland SmithKline Beecham PLC UK Jul 1989 – Apr 1996 SmithKline Beecham US Fortis (B) Belgium Jun 1990 – Dec 2001 Fortis (NL) Netherlands Dexia Belgium Belgium Nov 1996 – Feb 2000 Dexia France France Nordbanken Sweden Dec 1997 – Mar 2000 Merita Finland Allied Zurich PLC UK Sep 1998 – Oct 2000 Zurich Allied Switzerland
Reserve Bank of Australia Bulletin October 2002
price differentials. Although an investor in principle can take a short position in the relatively expensive asset and a long position in the relatively cheap one, this is risky as price differentials may subsequently widen, resulting in losses for the investor. This was indeed the experience of Long-Term Capital Management (LTCM), which held ‘arbitrage’ positions in Royal Dutch/Shell that resulted in losses when the price differential widened.^7
The six cases of unification of DLCs allow one to observe what happens to the prices of the individual twins when unification is announced. In all six cases, the unification involved the conversion of shares at the ratio implied by the distribution of voting power and dividends, rather than at a ratio implied by current market prices. Not surprisingly, the pricing of the twins converges in these cases, but it is of interest to ask if this occurs via an increase in the value of the company that is trading at a discount or a fall in the share price of the twin that is trading at a premium. Alternatively, both share prices might rise, or both might fall.
The limited number of events makes it difficult to draw firm conclusions about how the prices of each twin respond. However, some preliminary analysis suggests that the twin that was trading at a discount (four of the six cases were characterised by a significant price differential between the twins) on average saw price increases.^8 In some instances the premium company fell slightly in price, but the net result for the value of the combined company tended to be a modest increase in market value.
These findings are presumably a result of the particular way that the share unification occurs. In particular, unification typically
involves the company putting the new single primary listing on the market that had placed the higher valuation on the cash flows of the twin companies.^9 That is, management was undertaking a form of arbitrage by closing out the dual listing in the market that attached a lower valuation and moving the entire listing to the market which valued the company more highly.
The Three Australian/UK
DLCs
Three Australian companies are now part of DLCs as a result of mergers with UK-listed firms. The first DLC resulted from the 1995 merger of the Australian mining company CRA and UK-listed RTZ, which already held a 49 per cent stake in CRA. The two companies in the DLC have subsequently been renamed Rio Tinto Limited (which is traded on the ASX) and Rio Tinto PLC (which is traded on the London Stock Exchange). The reasons cited for implementing a DLC structure, rather than an outright merger, were the preservation of the franking of CRA’s dividends and the minimisation of capital gains tax liabilities.The voting rights and dividend flows of the group are divided approximately in the ratio of 77/23 between the shareholders of the UK and Australian companies, respectively. 10 The relative valuation of the two companies has shown significant variation, and each company has traded at a significant premium at different times. The Australian stock has traded at an average discount of around 2 per cent over the
- See Lowenstein (2000) for further details on LTCM’s US$2.3 billion position in Royal Dutch and Shell.
- The fact that the unification announcement was often also accompanied by other announcements that might have also affected the value of the companies means that the results should be regarded as tentative.
- The case of Fortis – where there was little discount or premium – is an exception, since the single share structure that eventuated did not have a single primary listing but had a dual primary listing on the Belgian and Amsterdam exchanges.
- Under the terms of the merger, in cases where the companies did not share a common interest, the 49 per cent of CRA held by RTZ would not be used to cast votes. The RTZ holding in CRA has since been reduced to about 37 per cent.
Reserve Bank of Australia Bulletin October 2002
accompanied by an increase of about 3 per cent in the price of the Australian twin relative to the UK twin, and vice versa for periods of underperformance.
The implication of these tests is that although the future cash flows that are being traded on the Australian and UK markets are the same, the pricing of the cash flows in the different markets is apparently influenced in the short run by differences in the relative performance of the two national markets. This may be one explanation why the relative valuation of the Australian twins tended to increase in the first half of 2002 in line with the stronger performance of the Australian equity market during that period.
However, excess comovement appears to be largely a short-run phenomenon 11 and would not appear to be able to explain why the value of one particular twin might be persistently higher than the other over long periods of time. As noted earlier, academic research has yet to find any consistent explanation for such divergences. In the case of the Australian
DLCs, fundamental factors (such as tax or liquidity factors) also appear to be unable to explain either the magnitude or variability of the price divergences.^12 The implication is that the price divergences reflect a range of behavioural factors affecting investors, such as their perceptions of the companies involved and the quality of the market infrastructure, including stock exchanges, that support trading in these companies’ shares. For example, a company that has ‘icon’ status in a particular country may benefit disproportionately from the home-country bias of investors in that country. While the reasons for on-going price divergences remain unclear, the fact that two of the three DLCs involving Australian companies have persistently traded at a significant premium in the Australian market relative to the UK market tends to refute claims that Australian companies can increase shareholder value by shifting their listing to larger overseas exchanges.
References
Froot KA and EM Dabora (1999), ‘How are stock prices affected by the location of trade?’, Journal of Financial Economics , 53(2), pp 189–216.
Glanz S and G Sanderson (2001), ‘Dual Listed Companies’, Baker & McKenzie Mergers & Acquisitions Practice Group Newsletter , July, Sydney. Hancock S, B Phillips and M Gray (1999), ‘When two heads are better than one’, European Counsel , June, pp 25–37.
Lowenstein R (2000), When Genius Failed: The Rise and Fall of Long-Term Capital Management , Random House, New York. Rosenthal L and C Young (1990), ‘The seemingly anomalous price behavior of Royal Dutch/Shell and Unilever N.V./PLC’, Journal of Financial Economics , 26(1), pp 123–141. Smith C and V Cugati (2001), ‘Innovative Structures – Dual Listed Companies’, Allens Arthur Robinson Focus on Mergers & Acquisitions , 1, Sydney. R
- Indeed the statistical tests establishing excess comovement over 10-day periods also suggest that this result is unwound somewhat over future periods.
- An alternative explanation that has been suggested is that divergences might reflect exchange rate expectations. This explanation seems highly unlikely, and it appears that the price differentials do not have any predictive power for the exchange rate.
