An applicant that fails the profit test but may pass the market cap/revenue test
A Hong Kong-incorporated industrial equipment maker applies for a Main Board listing. Its audited results show profit attributable to shareholders of HK$30 million in the latest year, HK$28 million and HK$22 million in the two preceding years, and revenue of HK$520 million in the latest year. The offer price implies an expected market capitalisation of HK$4.1 billion. The controlling shareholder, who will hold 55% after listing, also owns a separate company that supplies 20% of the applicant's components and sells competing equipment in Southeast Asia. The Application Proof filed with Form A1 does not mention that the applicant has not yet obtained a material environmental permit for its new production line; the sponsor's internal control report is in draft. The company's lawyers say the profit test is met because aggregate profits are HK$80 million. The sponsor asks whether the applicant is eligible and whether it can "fix" the permit in the prospectus.
1. Which Main Board financial eligibility test, if any, does the applicant satisfy? Explain the profit test calculation.
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The profit test is not a single aggregate figure. It requires:
- profit attributable to shareholders of at least HK$35 million in the most recent year; and
- an aggregate of at least HK$45 million in the two preceding years.
The applicant has HK$30 million in the latest year, which is below HK$35 million, so it fails the profit test. The fact that the three years add up to HK$80 million is irrelevant; the lawyers are adding the latest year to the two preceding years when the rule does not permit that. The two preceding years do aggregate to HK$50 million, which passes the second limb, but both limbs must be met.
The applicant should then be tested against the market capitalisation/revenue test: expected market capitalisation of at least HK$4 billion at the time of listing and revenue of at least HK$500 million for the most recent audited financial year. The applicant has HK$4.1 billion and HK$520 million, so it satisfies this test. It must still satisfy the trading record, management continuity, ownership continuity and suitability requirements.
2. What are the implications of the controlling shareholder's competing business and the supply relationship?
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The controlling shareholder's separate company creates two issues. First, suitability and independence: the Exchange will scrutinise whether the applicant can operate independently of its controlling shareholder. The fact that the controlling shareholder also sells competing equipment in Southeast Asia raises questions about diversion of business opportunities, management time and strategic direction. The applicant should demonstrate an independent board (including independent non-executive directors), independent management and independent operations. The Exchange may require a non-competition undertaking, clear delineation of markets, or disposal of the competing business, and the prospectus must disclose the conflict and how it is managed.
Second, the supply relationship: after listing the controlling shareholder remains a connected person, so the purchase of 20% of components from his company will be a continuing connected transaction. The applicant will need a written master supply agreement, annual caps, and compliance with the announcement, reporting, annual review and (if the caps exceed the thresholds) independent shareholders' approval requirements. The prospectus should disclose the historical and expected amounts, the pricing basis, and the safeguards. If the relationship is not on normal commercial terms, it could also affect the applicant's profitability and suitability.
3. What are the consequences of the missing environmental permit and the draft internal control report, and can they be fixed after the A1?
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The Application Proof must be substantially complete when the A1 is filed. A material environmental permit for a new production line is not a cosmetic omission: if the permit is needed for the business to operate as described, its absence is material information that investors need. Omitting it can lead the Exchange to return the application, with the applicant unable to re-file for eight weeks, and can expose the sponsor to disciplinary action for failing to ensure the accuracy and completeness of the listing document.
The internal control report is also a gating item. The sponsor must complete its review and be able to confirm that the applicant's internal controls are adequate. A draft report means the sponsor cannot yet give that confirmation, and filing on the basis of a draft would be inconsistent with the sponsor's obligations.
The permit cannot simply be "fixed in the prospectus" if it has not been obtained. The applicant must disclose the status of the application, the regulatory process, the timeline, the risks if the permit is delayed or refused, and any contingency plan. If the permit is a condition to lawful operation of a material part of the business, the Exchange may treat the applicant as not suitable for listing until the position is resolved. The sponsor should advise the board to resolve the permit and finalise the internal controls before filing, rather than relying on later disclosure.