RDP 2003-06: The Characteristics and Trading Behaviour of Dual-Listed Companies 2. Why Do Companies Choose DLC Structures?

DLC structures are effectively mergers between two companies in which they agree to combine their operations and cash flows, but retain separate shareholder registries and identities. One form 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 according to a predetermined ratio. Alternatively, instead of the transfer of assets, there may be contractual arrangements to share the cash flows from each other's assets. The operations of the two companies are closely coordinated, and in most cases the companies share a common board of directors.

Table 1 provides a listing of 14 existing or recently unified DLC structures.^[2] With one exception, all DLCs have been the result of mergers between companies domiciled in different countries.^[3] An examination of these cases 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 minimise capital gains tax obligations that would result from a conventional merger. Alternatively, home-bias and 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 management of 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, and 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 markets if it maintains listings in each market.
• Concerns over ‘flow-back’. In a conventional merger with a stock swap, the merged company will have to choose one country for its domicile and primary listing, and the shareholders from the other country will receive equity in a company domiciled in a foreign market. The merged company will now be a larger company and will see a higher weight in the share market index of its country of domicile, but it will disappear from the index in the other market. A DLC may be chosen if it is thought that a merger would result in selling pressure in one market exceeding increased investor interest in the other market.

However, the fact that most cross-border mergers do not take the form of a DLC and that some companies have decided to unify their DLC structures implies that there are also possible disadvantages to DLCs. These may include:^[5]

• Complexity of operations. The contractual arrangements of DLCs provide procedures for the treatment of the interests of the shareholders of both companies in the case of capital raisings, asset sales and other events. Nonetheless, the existence of two sets of shareholders may at times constrain the flexibility of management and the full benefits of a more conventional merger may not in practice be realised.
• Regulatory issues. The ongoing operations of the separate companies means that the DLC must satisfy the accounting and regulatory frameworks of two countries. This is likely to be costly, and may constrain the ability of management to maximise the joint value of the two companies.
• Liquidity, transparency and shareholder value issues. In practice, the existence of two separate companies may result in less share market liquidity than would result if there was a single larger company. In addition, investors may view the DLC structure as somewhat complex and less transparent than a conventional single company. Hence, they may value the two parts of the company less highly than they would a single larger company.

Footnotes

The table includes all those widely held DLC structures over recent decades that could be identified from a range of sources. It excludes cases of twins that do not trade separately. For example, in the Anglo-Irish Wedgwood/Waterford merger, shareholders in each company received an equity unit that consists of a share in each company. A similar arrangement occurred in the creation of the Anglo-French EuroTunnel enterprise. Unlike the cases discussed in this paper, the shares of the companies do not trade as different companies as the equity units cannot be split. The table also excludes cases of linked companies that did not have identical dividend flows. [2]

The exception is the recent case of Investec PLC/Limited. This Anglo/South African DLC was formed not from a merger, but from a ‘demerger’ and the creation of a new UK company holding the UK assets of the South African parent. As with other DLCs, the purpose of the transaction was to facilitate Investec's international expansion. However, the rationale for a DLC structure rather than a simple UK secondary market listing appears to have been to meet South African government requirements concerning exchange controls. Since Investec has a substantially smaller capitalisation than the other DLCs, this article focuses on the more conventional and larger DLCs created through mergers. [3]

Some of the reasons cited by companies in adopting DLCs are provided in the 12 April 2001 ‘Proposed DLC Merger Explanatory Memorandum’ from BHP Billiton and the 25 June 2001 ‘Information Memorandum: Dual Listed Companies Proposal’ from Brambles. Hancock, Phillips and Gray (1999), Glanz and Sanderson (2001), Smith and Cugati (2001), and Hancock, Gray and Sommelet (2002), also provide further discussion of DLCs, and their advantages and disadvantages relative to conventional mergers. [4]

Further details on the factors that lead companies to end DLC structures are provided in the 28 August 2000 press release by Fortis, the 17 April 2000 ‘Share unification plan’ presentation of Zurich Financial Services, and the 1999 Annual Reports of Dexia, ABB and MeritaNordbanken. [5]