Falling public equity markets make SPACs look compelling

SPAC Attack
Posted on March 20, 2008

(The Deal) The IPO window is all but closed, while the SPAC door looks wide open.

SPACs, or blank-check public offerings, are here to stay, having represented 21% of cash raised in the IPO market in 2007, notes Deal contributor Joseph Bartlett. "The SPACs phenomenon is based on fundamental shifts in the U.S. financial markets, the first being the extended closure (since 2001) of the IPO window in the U.S. for small- and midcap companies."

So what are they, exactly? The Deal's Vyvyan Tenorio offers a primer:

As blind pools, SPACs don't have an operating business when they raise money in public markets. But they have 18 months from an IPO to complete a deal using about 80% of net assets. Up to 95% of the money raised is held in a third-party trust. Once a SPAC has identified a target, it has to notify shareholders and submit documentation to the SEC. Shareholders can approve it and sell or redeem their shares. If the SPAC fails to successfully make an acquisition, the trust is liquidated and the cash returned.

SPACs are an investment favorite of hedge funds (Amaranth Advisors LLC loved 'em before its spectacular implosion) and, of late, large institutional investors like mutual funds. She writes:

Clearly there's an appetite for SPACs among sponsors whose access to capital may be limited, and among hedge funds that hope to profit from arbitrage opportunities. SPACs have also opened avenues for well-heeled financiers such as Texas private equity pioneer Tom Hicks. In June, Hicks filed to raise $400 million through an IPO for a SPAC. [He wound up raising $552 million in October.] Hedge funds, too, are exploiting these vehicles to take themselves public. GLG Partners LP, one of Europe's largest hedge funds, went public in 2006 through a reverse $3.4 billion takeover of Freedom Acquisitions Holdings Inc., which raised $528 million late in the year.

And they're also a popular exit route for private equity firms, notes The Deal's John Morris. (For other ways PE firms can capitalize, see below.) Eleven SPACs have bought private equity-controlled U.S. companies since mid-2006, he says, citing a SPAC tracker.

THE GOOD, THE BAD AND THE FIXES

More generally, SPACs seek to overcome some of the problems involved in the back-door route -- reverse merger into a public shell. It's a two-step process, Sonnenschein Nath & Rosenthal LLP's Bartlett notes: An underwritten IPO followed by an acquisition, effectively a back-door IPO but with built-in safeguards, promising shareholders get a say in choosing the target. He lays out the plusses, particularly when compared to shells, and the minuses:

• It affords retail investors access to many advantages of private equity. While hedge funds typically buy the stock, any average investor can too.
• Investors buy what the SPAC has set out to do; whereas investors in a shell are bystanders.
• And shareholders can vote for a deal or against it and recoup much of their investment, which is far less common with shells.
• All told, a SPAC deal is still a reverse IPO, so if a company is to float successfully, why not use the traditional avenue? The road is shorter, cheaper and less risky. But the window, for now, is closed.
• Further, many deals involve proceeds that fall short of the amount deemed advisable to escape orphanage, a problem that can be countered with rollups.

The remaining issues are tougher, he notes:

• How attractive is a company willing to hang around an average of 218 days for a yes vote that may or may not come? "If it is any good, it should be snapped up quickly by financial and/or strategic investors."
• And a no vote can be catastropic. "Take a look at the stock price nosedive of targets left at the altar by LBO funds reneging at the last minute." (For more on buyouts gone bust, see a related Dealwatch.)
• Further, once proxy materials go out, anyone can take a peek: competitors as well as customers.
• The 18-month deadline imposes tremendous pressure to cut a deal.

So what are the fixes?

• For SPACs themselves, a team-up with a PE fund may be the best model. (See below.) Potential conflicts of interest surrounding the role of private equity investors in SPACs can also arise, but the shareholders always have the cash-out option.
• Meanwhile the SEC needs to regulate to prevent market manipulation (one SEC rule is that SPACs can't predetermine acquisition targets, a contested point because they're often industry-specific) and the average 218-day delay (also aimed at preventing abuse) from sign to close needs to be shortened.
• Finally, reliable data on post-closing stock performance is essential, he notes, to help investors decide which SPACs and targets will withstand the after market.

GAME PLAN

SPACs are trying to differentiate from the checkered past of blind pools, note William F. Griffin Jr. and Andrew D. Myers, shareholders with Davis, Malm & D'Agostine PC. There are investor protections: the aforementioned shareholder vote on acquisitions and cash-out option; management and frequently underwriters have skin in the game via stock and warrant purchase agreements and deferred fees, respectively; a relatively small amount of offering proceeds go toward working capital to consummate an acquisition.

So for a private equity investor, there are three ways to go about getting into the SPAC game, notes the SPAC lady herself, Tina Pappas, a managing director with boutique investment bank Morgan Joseph & Co.:

• Sponsoring a SPAC as an issuer: PE firms that have done so include: MBF Healthcare Partners LP, Steel Partners, LLM Capital Partners LLC, Camden Partners Holdings LLC and GSC Group, while several others are in registration.
• Exits for existing investments: 72 SPACs have more than $12.3 billion in capital looking for acquisitions. She calls a reverse merger one of the most compelling options.
• Co-investing in a SPAC acquisition: In an arrangement where an existing consortium of SPACs just need some more cash to complete a transaction, a firm could come in and perhaps be entitled part of the founders' 20% ownership right and warranty options.

A DIFFERENT ANIMAL

And in a then-recent twist, Tenoiro noted in July:

SPACs have now tapped the Rule 144A [under which an issuer can offer a private sale of securities to qualified institutional buyers, or QIBs, without government oversight] market for privately issued, unregistered securities, which coincidentally is an increasingly popular alternative for private equity firms looking to go public.

It affords more flexibility, she writes, as QIBs are perceived as sophisticated institutional buyers who don't need the same protections as individual or smaller investors. They're not subject to the long SEC review process (drawn out to guard against potential abuses). And how many 144A SPACs there have been is hard to say, given that they're private placements, she writes. "Not surprisingly, sources say investors in these offerings are essentially the same community of hedge funds that invest in SPACs."

And after the IPO come the mergers. McDermott Will & Emery LLP's Joel L. Rubinstein and Dennis J. White weighed in on the nuances in September. Unsurprisingly, competition for the listings is fierce. As The Deal's Donna Block noted Feb. 21: Nasdaq's move to institute new listing standards for special purpose acquisition vehicles is an attempt to capture American Stock Exchange listings. - Carolyn Murph