Talking stock of the Second Board

A Shell Premium Theory

Share prices on the Second Board have soared up to historical highs. The prices are certainly far above the values formally justified by standard capital asset pricing models. Most of these second board stocks do not have the earnings or the asset backing to support the existing valuations.

So why then? Is the rise a "pure speculative bubble" which will ultimately burst? Maybe. But then again maybe not.

Market watchers will want to know whether such high prices are sustainable and fundamentally-based. On the usual theories of asset pricing, there is very little to offer as the prices do not seem to correlate with earnings and market PEs. But there may be other grounds to think that these high prices on second board prices can be justified.

How do we test this theory?

Lower Paid Up Companies

Higher Paid up Companies

The high second board price premiums



A Shell Premium Theory

Second board stocks have a small paid-up capital and are therefore natural takeover targets. As listing shell premiums currently command a price of about RM$200 million, a second board company with a 20 million paid-up should be valued at a minimum value of RM$10 per share. Takeover values of about $10 a share for such small paid-up companies can therefore be justified.

Assuming there are many owners of private assets with high values, then there will always be a fairly strong demand for such listed vehicles. The number of such owners increases strongly in a growth economy particularly with rising property values and numerous privatised concessions. As the take-up rates for for such vehicles rises, it is quite natural for the prices of second board shares to be valued at a minimum of $10 per share.

How do we test this theory?

First, if the above is true, then the value of a "stripped-clean" listed shell company is worth at least RM$200 million irrespective of the paid-up capital. So if we compare two companies with the same earnings on the Second Board but have different paid-up capital, then the company with the smaller paid-up capital will be priced at a higher price per share.

More specifically, suppose Company A has a paid-up of 20 million shares and Company B has a paid-up of 40 million shares, then we would expect Company A's theoretical takeover price as a shell will be $10 per share based on a takeover premium of $200 million, and for Company B at a price of $5 per share.

For many second board companies, the above "shell premium effect" will dominate over the "earnings effect" on share prices. As a result, we should be able to observe a negative correlation between share prices and the paid-up capital of the companies. A glance at some second board counters confirm this pricing pattern.




Lower Paid Up Companies


Paid-up Capital

Close Price
(Oct 31, 1996)


















$ 9-40



$ 9-70


Higher Paid up Companies


Paid-up Capital

Close Price
(Oct 31, 1996)

Len Brothers






Reliance Pacific



Tengggara Capital



Brem Holdings






Ireka Construction



The above theory also explains why the main board companies have not fetched such high share prices. A fixed shell premium of $200 million spread over a larger paid-up of a main board company will be much less significant and may end up being a few dollars per share.

For larger companies then, the dominant effect will therefore come from the standard "earnings effect" rather than the "shell premium effect". Valuations for main board companies can then be accounted for from the standard CAPM model.



The high listing shell premiums that owners of private assets are willing to pay is inevitably tied to the stringent SC requirements for listing. Track records and profit guarantees are pre-qualifications for listing. Many private assets and privatisation concessions cannot meet such criterias. This inevitably generates a demand for listed shells with companies on the second board getting the bulk of the gains. So long as the strict rules for listing remains, the premiums on the Second Board are fundamentally based and is sustainable as there is a genuine demand for the listed status of such companies.

To eliminate such second board premiums, if indeed this is a desirable outcome, the authorities can probably do one of several things.

First, abolish all the strict requirements for listing, particularly for small-cap stocks, such as the profit track records. If entry costs into the Second Board are reduced, owners would rather opt for a direct listing rather than a back-door listing. This may not be as bad as most regulators would think. If the authorities are already allowing for reverse takeovers and the back-door listing of assets which do not have profit track records, then why not allow them to do it through the front door?

Second, raise the minimum paid-up of Second Board counters to 50 million shares or higher. As shown in the table above, companies with the higher paid-up do not fetch excessively higher prices per share. The earnings effect will then be the dominating factor in determining their share prices.

Third, crash the property market and stop giving privatisation concessions. The sustainability of these high Second Board prices are inevitably tied to the growth of the economy. If the economy turns for the worse, the shell premiums will disappear and the Second Board will crash. If however the economy sustains its growth at a healthy rate, then do not be surprised if the shell premium also grows steadily and the Second Board share prices grow at the same interest rate as we see for our savings account.

Is all the above said that surprising? There are some remarkable conclusions if the above theory is accepted.

First, the high second board prices are fundamentally based and are therefore sustainable in a steady growing economy. Demand for listed vehicles will remain so long as there is a rising number of owners with valuable private assets. So all the warnings about an inevitable crash on the second board stocks can be dismissed.

Second, standard pricing models are therefore more applicable to main board companies with a large paid-up capital. For small companies, the shell premium theory will be more applicable as the shell premium effect dominates the earnings effect. More importantly, the two theories are not necessarily inconsistent with each other, and can both be utilised in explaining share prices.

Third, there are some interesting policy implications. If the authorities suddenly decided to tighten the rules for listing on the Second Board, the shell premiums will rise, and the Second Board index will be able to break 700. If the authorities decide to continue their liberalisation drive and loosen listing restrictions, the listing premiums will collapse as direct listing will be an easier option, and the Second Board index will crash.

Dr Chua Hak Bin works as a senior executive in a KLSE-listed company. The opinions expressed are solely his own. This article was also published in The Edge, November 25, 1996.

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