SGX should maintain a minimum trading price rule, but not for the originally intended reasons

In my experience, however, the lower a company’s absolute share price, the less likely it is to have a strong and growing business. Companies that are thriving, and that engage investors effectively, almost never have shares priced at just a few cents. And, if a company’s share price ever slumps into the ignominious sub-one-cent space, it is usually because something has gone terribly wrong.

Three years ago, the Singapore Exchange made an attempt to rid the market of low-priced stocks, by requiring Mainboard-listed companies to maintain a six-month volume-weighted average price of at least 20 cents, and a six-month average daily market capitalisation of at least $40 million. Companies that failed to meet these criteria were placed on a watch list and given three years to get their stock price and market capitalisation up to the appropriate levels. Those that still failed to meet the necessary criteria would then be forced to delist.

The stated rationale of this minimum trading price rule was to improve the overall quality of the local stock market, and reduce the possibility of the low-priced shares of small companies being manipulated. Judging from its public statements on the matter, SGX appeared to think that companies susceptible to running afoul of the MTP rule would be able to take some kind of action to avoid being placed on the watch list.

In February 2015, before the MTP rule was implemented, a senior SGX official said, “We urge companies to take action as soon as possible to comply with MTP. Share consolidation would be the most practical option and companies with AGMs in April 2015 should leverage on convening an EGM on the same date, to obtain shareholders’ approval of the share consolidation. Others may consider transferring to Catalist, a sponsor-supervised regime and a value proposition for high-growth companies.”

This turned out to be easier said than done. According to SGX, not a single company has managed to exit the MTP watch list by complying with the MTP rule, though 10 have escaped by transferring their listings to the Catalist board. There are currently 101 companies on the MTP watch list. By some estimates, more than 50 companies on the watch list could face delisting if they fail to comply with the MTP rule by June next year.

Now, SGX is having second thoughts about the MTP. Earlier this month, SGX said it was reviewing the MTP rule in response to feedback, and that it was prepared to “go as far as to remove the policy”. According to SGX, it has developed other tools that are more effective in addressing the risk of stock manipulation. Moreover, share consolidation exercises by companies to meet the MTP criteria did not bolster their share prices as much as expected, and led to further declines in their market capitalisation.

So, what is to become of all the stocks on the MTP watch list? Will the reprieve from being forced to delist spur a rally in these counters? Is removing the MTP policy a good thing from the perspective of investors?

Uncomfortable truths

SGX’s experiment with the MTP rule has revealed some uncomfortable truths about the local market. For one thing, if share consolidation exercises had the effect of shrinking the market capitalisation of companies attempting meet the requirements of SGX’s MTP policy, the corollary must surely be that having low-priced shares helps many small locally listed companies inflate their market capitalisation.

One explanation for this phenomenon is that stocks trading at low absolute prices deliver relatively large percentage gains or losses when they move by a couple of ticks, making retail investors more willing to hold them even though their fundamentals might not be great. For instance, the smallest price increment for stocks trading at $1 or more is $0.01. So, moving up a single tick delivers a gain of no more than 1%. On the other hand, the minimum price increment for stocks priced from $0.20 to $0.995 is $0.005. So, a single tick delivers a gain of as much as 2.5% at the bottom end of that price range.

For stocks priced below $0.20, the minimum bid size is $0.001. So, $0.001 is the lowest price at which a stock can be traded in the local market. Moving up a single tick from that level would translate to a gain of 100%. Indeed, one could argue that an investor who holds shares priced at $0.001 would have very little reason to sell. Even if the company is worthless, the investor would face no downside risk unless the company is wound up.

Interestingly, some companies have attempted to issue shares priced below $0.001. On Feb 27, Renaissance United (formerly known as IPCO International) said it would issue 1.23 billion new shares priced at $0.0009 to raise net proceeds of just over $1.037 million. The company said the subscribers were two individuals, named Tan Chin Chuan and Tan Chek Meng, who would end up owning nearly 16.6% of the enlarged company. As the new shares Renaissance United proposed to issue cannot trade any lower than $0.001, this exercise would have artificially inflated the “market value” of the company, and the two Tans would have been sitting on an immediate paper gain.

On April 1, however, Renaissance United said SGX had rejected its application for the listing and quotation of the new shares. On May 7, the company said it had revised the issue price of the new shares to the two Tans to $0.0011 a share. It subsequently announced two extensions to the longstop date. On Aug 14, the company said its independent auditors had issued a “disclaimer of opinion” in their report on its financial statements for the year to April 30. Renaissance United is among the more than 50 companies that could be delisted if it fails to comply with the MTP rule by June next year.

This brings me to another troubling revelation from SGX’s experiment with the MTP rule: the fact that no company that has stumbled onto the MTP watch list has managed to turn itself around and exit the list. Are companies simply past the point of redemption when their share prices fall below 20 cents and their market values tumble to less than $40 million? Perhaps billionaire investor Warren Buffett was right when he warned in his 1979 letter to shareholders of Berkshire Hathaway that turnarounds are hard to pull off.

Referring to investments Berkshire Hathaway had made in its waning textiles division in preceding years, Buffett said: “Both our operating and investment experience cause us to conclude that ‘turnarounds’ seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price.”

SGX should tweak MTP

In my view, it would be a mistake for SGX to abandon its MTP policy entirely. SGX may well have developed more effective tools to curb stock manipulation, but having a clear and strictly enforced MTP rule could contribute significantly to its goal of improving the overall quality of the market.

While it is evident that companies struggling with sinking share prices do not easily turn around, the boards and management of such companies often have little incentive to shrink the failing business and return capital to shareholders. They are more likely to choose to keep themselves employed and continue bleeding investors with subpar returns. Against this backdrop, it seems to me that a blunt instrument such as an MTP could benefit ordinary investors, if it compels the board and management of failing companies to quickly organise a sale or liquidation as part of a mandatory delisting.

I would suggest, however, that SGX make a few tweaks to its MTP policy. For starters, it should consider applying the MTP rule without any market capitalisation criteria. Companies on the brink of failure come in all sizes. Commodity supplier Noble Group, for instance, still had a market capitalisation of more than $100 million last year, despite having lost more than 98% of its value over the preceding four years amid accusations by Iceberg Research that it had been artificially inflating the value of its assets and understating its liabilities.

More importantly, SGX should consider abandoning the MTP watch list, and the three-year cure period for companies that have breached the MTP rule. It ought to be the responsibility of the boards and management of Mainboard-listed companies to monitor their own share prices, and take action long before they are in danger of breaching the MTP threshold. They may, of course, fail to convince investors that they will be able to turn things around. In that event, the market would — quite rightly — quickly drive these companies towards delisting. Investors own shares to make money, not listen to lame excuses.

SGX should also set the MTP threshold with consideration for the price at which shares are normally sold in IPOs, so that companies are not unnecessarily put at risk of delisting because of a cyclical downturn in their businesses. Given that the minimum IPO price of shares to be listed on the Mainboard is currently $0.50, the MTP should perhaps be set at $0.10 instead of the current $0.20. If a company, after selling shares to investors at $0.50, finds its share price down almost 80% and in danger of falling below $0.10, its board and management would be not be able to claim that they weren’t given sufficient opportunity to prove themselves.

Of course, if it becomes clear that SGX will strictly enforce its current MTP of $0.20, and not grant endless extensions or permission to shift to the Catalist board, companies may well begin choosing to launch IPOs at higher prices. Whatever the case, we might see the day when no investor will need to know that the lowest possible price at which a stock can trade is $0.001.