Older article on appeal of SPACs

BLANK CHECK COMPANIES
In a chilly IPO market, blank check companies are hot
By Robert Elder
AMERICAN-STATESMAN STAFF
Sunday, March 02, 2008

It's been a rocky year for initial public offerings, but investors can't get enough of companies that have no assets, no operating history and no business plan.

They are called special-purpose acquisition companies —shell companies that aim to acquire a business, usually within two years after it has raised money in an IPO. Investors don't know what kind of business a company will acquire or whether it will complete a deal, that's why they are also called blank-check companies.

Austin media entrepreneur R. Steven Hicks is the latest big-name investor to announce plans for a special-purpose company, joining the likes of his brother Dallas billionaire Thomas Hicks and activist investor Nelson Peltz, each of whom has raised hundreds of millions of dollars in special-purpose company IPOs.

Steven Hicks plans to raise a more modest $186 million for his blank-check company, Austin-based Capstar Acquisition Corp. The IPO was expected to launch this month, but Hicks said Thursday that the offering would be delayed three months until the financial markets settle down.

The delay in Capstar's offering, though, appears to be an anomaly.

"I hate to use the word 'bubble,' but clearly there's a stampede going on to get SPACs to the (IPO) market," said Steven Davidoff, a law professor at Wayne State University who has written extensively on the capital markets.

This year, 11 of the 19 companies that have raised money in IPOs have been special-purpose companies. Overall it's been a down year for IPOs: 19 companies have priced, a 49 percent decline from the same period in 2007.

But 11 of those 19 have been special-purpose companies.

The reason for the stampede by investors is more of a mystery. The structure of a special-purpose company is heavily tilted in favor of its executives, who typically end up with 20 percent of a newly acquired company, essentially for free.

In a new paper, Davidoff says special-purpose companies are part of a surge in what he calls black market capital, investments that "attempt to mimic the characteristics of hedge funds or private equity."

Average investors are effectively shut out of hedge funds and private equity, which are restricted to wealthier individuals. So they instead seek investments such as special-purpose companies they think can provide the outsized returns sometimes earned by private equity.
A special-purpose company, though, doesn't resemble a buyout fund, which may buy dozens of businesses, spreading the risk. A special-purpose company buys one company and usually has two years to do it.

Patience is a virtue in private equity, said Keith Garrison, a private-markets specialist at the Texas Christian University endowment and the former head of private equity at the $107 billion Teacher Retirement System of Texas pension fund.

At the teacher fund, Garrison said, "We had buyout groups that didn't invest capital for two years, just because the market was terrible."
"That was fine with us," he said. "We would not want them to be on a timelime. If they were, they would maybe be compelled to do things that don't make sense."

Davidoff said it's a no-brainer why managers are lining up to form special-purpose companies: They can raise money in a single IPO, rather than through endless fundraising meetings with potential private investors.

There are some protections for shareholders, a result of some blank-check companies failing in the 1980s and losing investors' money.
First, investors must approve the acquisition of a company.

Capstar says it will require 80 percent of shareholders to approve a deal, while other special-purpose companies have put the bar as low as 60 percent.

Second, if a company isn't acquired by the deadline, investors get close to 100 percent of their money returned. The only risk is the money an investor foregoes by having tied up funds in a special-purpose company for two years.

Investors are largely betting on the ability of a management team to find a business.

Someone who buys into Capstar is betting that Hicks can find another hugely profitable deal. Capstar's securities filings say its executives will try to buy a company in the media or entertainment business, but it doesn't have to limit itself to those industries.

Hicks and his brother Tom rode the consolidation wave in the radio industry in the 1990s. With financing from Tom Hicks' buyout firm, Steven Hicks and longtime associate John Cullen built Capstar Broadcasting Corp. into an industry giant.

They sold Capstar to Chancellor Media for $4.1 billion in 1999.

Cullen is president of DMX Inc., a programmed digital music company controlled by Hicks' private investment firm.

Hicks also runs Harden Healthcare, which is acquiring nursing facilities and home health and hospice agencies.

Special-purpose companies as a whole don't have a record investors can judge. Since 2003, about 47 of the 151 companies that have formed have completed deals, according to SPAC Analytics. In the majority of those cases, it's too soon to tell how investors have fared.
As of Feb. 22, there were 25 companies that had deals pending and 73 — with about $13 billion in capital — were looking for deals.
The scramble to make a deal can resemble a scavenger hunt. Endeavor Acquisition Corp., a New York-based special-purpose company, bought American Apparel in 2007, but only after it failed to buy other businesses.

Endeavor said it unsuccessfully tried to acquire two restaurant chains, a national chain of weight-loss centers and an ethanol producer in the Midwest.

So how did Endeavor settle on American Apparel?

In a filing with the U.S. Securities and Exchange Commission, Endeavor said its chairman and chief executive, Jonathan Ledecky, got the idea after he asked a consultant what kinds of products he liked. The consultant, Martin Dolfi, said he liked American Apparel clothes, and based on that Ledecky ordered research into the company, which led to the acquisition.

"Not all of these SPACs are going to work out," Davidoff said. "In the end, you're creating a race for everyone to cash in before it all pops."

Companies' workings
Special purpose acquisition companies, also called blank-check companies, are flooding the market for initial public offerings. Here's how they work:

Directors and executives get stock in the company at vastly discounted prices.

The company raises money from investors in an IPO and places the money in a trust.

It has 24 months to invest the proceeds.

If deadline isn't met, investors receive about 98 percent of their money back.

Stockholders must approve the company's first proposed investment, which must use at least 80 percent of company's capital.
Management ends up with 20 percent of the acquired company — essentially for free.

Investors can exercise their warrants to acquire additional shares in the acquired company.

The Big Mac (New York Times Article)

The Big MAC
The Deal Professor by Steve M. Davidoff
March 10, 2008, 11:00 am

(Dealbook) We are now a good nine months into the market turmoil that began early last summer. The crisis has left a host of dead deals and tarnished companies in its wake — not to mention scores of scarred merger arbitrageurs who were repeatedly blindsided by cratered transactions.

Material adverse change clauses have played a critical role in these disputes. They have been the lever by which a number of buyers have sought to escape from takeover agreements. In Genesco, HD Supply, SLM and Accredited Home Lenders, among others, buyers have asserted MAC clauses to justify not completing their deals.

That’s a fair number of data points, and so it’s time to take stock of what we’ve learned.

A MAC Invocation is the First Step in a Negotiation
The historical notion of MAC disputes as a renegotiation tool has once again been borne out.

The reason is inherent in the way these clauses are structured. A MAC (also called a material adverse event/effect, or MAE) clause is a way for parties to allocate risk. When a company agrees to be acquired, there will almost always be a period of time between when the original acquisition agreement is executed and the transaction is completed. A MAC clause is a means for the parties to contractually allocate who will bear the risk of adverse events during this interim period. One formulation is “an effect, event, development or change that, individually or in the aggregate, is materially adverse to the business, results of operations or financial condition of the company and its subsidiaries, taken as a whole.” This is a qualitative test and not phrased in dollar terms.

The reason the parties don’t use dollar figures is bargaining leverage. A buyer can invoke a MAC to drive the price of an acquisition down by taking advantage of either changed market conditions or adverse events affecting the company to be purchased. Conversely, even though the buyer may utilize a MAC clause in this manner, a seller may also prefer a qualitative MAC clause to provide it with leeway to argue that an adverse event does not constitute a MAC. In both cases, the MAC clause works for the parties to settle typically at a lower price. The impetus towards settlement is compounded by the lack of substantial case-law on what constitutes a MAC. This is a self-fulfilling loop.
This is what we have seen in the recent wave. All of the MAC cases have been ultimately resolved through settlement rather than a determinative judicial judgment, though one difference has been that only a few deals, such as Accredited Home Lenders/Lone Star, have actually been renegotiated at a lower price; most have settled for a payment by the buyer to the seller, with deal itself being terminated.
And so, despite the relatively large number of MAC disputes, we thus far have only one judicial opinion further defining the scope of a MAC. This was the opinion of the Tennessee Chancery court in Genesco v. Finish Line. Unfortunately, the opinion of that court is not likely to be precedential or particularly useful because of its unique posture under Tennessee law and somewhat flawed reasoning.

Private Equity Buyers Can’t be Trusted with MAC Clauses
The negotiating balance between buyers and sellers that a MAC clause creates has been upset by the structure of private equity transactions.

Private equity deals typically have had a reverse termination fee structure that permits the buyer to exit the deal for any reason by paying a lump sum, typically about three percent of the transaction value. In these circumstances, sellers often rely partially on “soft” factors such as reputation to ensure a deal closing.

The problem with this structure is that it sets an upper bound for maximum damages, and mitigates the risk to a private equity firm in invoking a MAC compared to strategic deals, where the buyer can be forced to complete the deal if no MAC is found. Moreover, a private equity firm may be more incentivized to invoke a MAC to “cover” for the reputational issue.

This is what appeared to happen in a host of deals in the fall. One example is the failed Acxiom transaction. In those deals, a MAC was invoked, but a settlement was reached along the lines of the reverse termination fee, but for slightly less.

So where does that leave us? In private equity deals, parties may want to rethink the inclusion of a MAC clause. Given the continued use of the reverse termination fee structure in private equity deals, the inclusion of a MAC clause provides the private equity firm cover to invoke the MAC clause to “completely” walk from the transaction. Given the damage a MAC claim inflicts on a company, the company will be heavily incentivized in such circumstances to settle out at a lower figure, setting the reverse termination fee as an upper bound of payment.

While we are seeing anecdotal evidence that MAC clauses are getting more seller-friendly, it still does not fully address this issue. If private equity firms are going to obtain the optionality they want, preserving compensation for the seller in a busted deal is an equally worthy goal. This is particularly true since private equity firms are most likely to invoke the reverse termination fee structure in MAC-type situations. Strike a blow for seller rights: Kill the MAC in private equity deals.

The MAC Exclusions Matter
There is also a renewed focus on the carve-outs in every MAC clause. These carve-outs define events that, while materially adverse, are excluded from the definition of a MAC clause. As such, they are the principal place in a MAC clause where buyers and sellers allocate closing risk. The parties can agree any carve-out they wish, but generally parties negotiate carve-outs that allocate market and systemic risk to the buyer and allocate closing risk to the seller for adverse events that particularly and disproportionately affect it.

The SLM and Genesco disputes in particular brought renewed focus on the wording in these carve-outs. There, the parties were seemingly surprised at the exclusions they had negotiated. In SLM’s case it was the scope of the meaning of “disproportional” in a MAC exclusion for changes in laws related to the student lending industry. The Genesco dispute highlighted the potentially wide out an economic industry exclusion could provide a seller in a MAC. The lesson is that these exclusions may be wider than you think and that they are the heart of a MAC clause. Pay attention.

A new MAC strategy has also emerged. In the Genesco case, Finish Line did not initially invoke a MAC. Rather it claimed that the merger agreement among the parties required Genesco to provide Finish Line further information to make such a determination. Despite Genesco’s cries that this was a fishing expedition, the court ordered that Genesco provide such information. Sure enough, Finish Line subsequently claimed a MAC.

Wachovia is following a similar strategy in its litigation to escape financing the Clear Channel/Providence transaction. Wachovia is claiming that it needs further information to make a determination of whether a MAC to the Clear Channel television station business has occurred. This is a claim that, at a minimum, will delay a transaction.

But this strategy is already getting a cold reception in Delaware. Last week, at a hearing on the Clear Channel/Providence/Wachovia litigation, Vice Chancellor Leo Strine Jr. stated to Wachovia’s counsel:

I’m saying is I don’t know what claims you’ve made yet. If what you’re
claiming is that there was some sort of breach of covenant by your client
whereby they were supposed to have been providing certain types of information,
then I understand that there may well be a relationship between that failure to
provide information and your ability to claim an MAE if the information that you
did not get would justify such a call.

But, on the other hand, if you basically already have it, or you really
haven’t been able to call it, then, again, we’re not in that business, and I
don’t think that’s the law of contracts, that you go get to hit and hope.

Translated: Delaware is likely to be less friendly to fishing expeditions or other claims that this is information not in your possession.

And an Example
Let’s conclude by giving an example of an actual MAC clause, the one in the Countrywide’s merger agreement with Bank of America. That agreement defines a material adverse change as:

a material adverse effect on (i) the financial condition, results of operations or business of such party and its Subsidiaries taken as a whole (provided, however, that, with respect to this clause (i), a “Material Adverse Effect” shall not be deemed to include effects to the extent resulting from (A) changes, after the date hereof, in GAAP or regulatory accounting requirements applicable generally to companies in the industries in which such party and its Subsidiaries operate, (B) changes, after the date hereof, in laws, rules or regulations of general applicability to companies in the industries in which such party and its Subsidiaries operate, (C) actions or omissions taken with the prior written consent of the other party, (D) changes, after the date hereof, in global or national political conditions or general economic or market conditions generally affecting other companies in the industries in which such party and its Subsidiaries operate or (E) the public disclosure of this Agreement or the transactions contemplated hereby, except, with respect to clauses (A) and (B), to the extent that the effects of such change are disproportionately adverse to the financial condition, results of operations or business of such party and its Subsidiaries, taken as a whole, as compared to other companies in the industry in which such party and its Subsidiaries operate) or (ii) the ability of such party to timely consummate the transactions contemplated by this Agreement.

This is a middle-of-the-road MAC clause. (For a more seller-friendly one, see the Penn Gaming/Fortress merger agreement.)
Consider recent reports that the FBI is conducting a criminal inquiry into Countrywide: Would that be a MAC, thereby triggering a walk right by Bank of America? Hard to say — a walk right is only triggered if there is a breach of a representation and warranty that rises to the level of a MAC. This investigation certainly might cause such a breach of Countrywide’s representations as to no legal action or compliance with laws.

But to be a MAC, the investigation would have to be something that was not disclosed on the disclosure schedules to the merger agreement that qualify this representation. It would also have to have had or would reasonably be expected to have a MAC on Countrywide.
The disclosure schedules are not public, so we don’t know the answer to the first question. As for the second, a mere investigation is hard to be a MAC; one view is that unless the actual investigation itself causes the MAC, then there is none.

So right now, we just simply don’t know — though it seems not to be one.

Anchoring in auctions

Why Things Cost $19.95

What are the psychological "rules" of bartering?

By Wray Herbert

(Scientific American) One of Alfred Hitchcock’s most enduring bits of cinematic comedy is the auction scene in the espionage thriller North by Northwest. Cary Grant plays Roger Thornhill, a businessman who has been mistaken for a CIA agent by the ruthless Phillip Vandamm. At a critical juncture, Thornhill is cornered by his enemies inside a Chicago auction house, and the only way he can escape is by drawing attention to himself. When the bidding on an antique reaches $2,250, Thornhill yells out, “Fifteen hundred!” When the auctioneer gently chides him, he loudly changes his bid: “Twelve hundred!” When the bidding on a Louis XIV chaise longue reaches $1,200, Thornhill blurts outs, “Thirteen dollars!” The genteel crowd is outraged, but Thornhill gets precisely what he wants: the auctioneer summons the police, who “escort” him past Vandamm’s henchmen to safety.

Clever thinking and good comedy. It is funny for a lot of reasons, and one is that Thornhill violates every psychological “rule” for how we negotiate price and value with one another. So much of life involves “auctions,” whether it is buying a used car or making health care choices or even choosing a mate. But, unlike Roger Thornhill, most of us are motivated by the desire for a fair deal, and we employ some sophisticated cognitive tools to weigh offers, fashion responses, and so forth—all the to-and-fro in getting to an agreement.

But how does life’s dickering play out in the brain? And is it a trustworthy tool for getting what we want? Psychologists have been studying cognitive bartering for some time, and several basics are well established. For example, an opening “bid” of any sort is usually perceived as a mental anchor, a starting point for the psychological jockeying to follow. If we perceive an opening bid as fundamentally inaccurate or unfair, we reject it by countering with something in another ballpark altogether. But what about less dramatic counter offers? What makes us settle on a response?

University of Florida marketing professors Chris Janiszewski and Dan Uy suspected that something fundamental might be going on, that some characteristic of the opening bid itself might influence the way the brain thinks about value and shapes bidding behavior. In particular, they wanted to see if the degree of precision of the opening bid might be important to how the brain acts at an auction. Or, to put it in more familiar terms: Are we really fooled when storekeepers price something at $19.95 instead of a round 20 bucks?

Janiszewski and Uy ran a series of tests to explore this idea. The experiments used hypothetical scenarios, in which participants were required to make a variety of “educated guesses.” For example, they had subjects think about a scenario in which they were buying a high-definition plasma TV and asked them to guesstimate the wholesale cost. The participants were told the retail price, plus the fact that the retailer had a reputation for pricing TVs competitively.

There were three scenarios involving different retail prices: one group of buyers was given a price of $5,000, another was given a price of $4,988, and the third was told $5,012. When all the buyers were asked to estimate the wholesale price, those with the $5,000 price tag in their head guessed much lower than those contemplating the more precise retail prices. That is, they moved farther away from the mental anchor. What is more, those who started with the round number as their mental anchor were much more likely to guess a wholesale price that was also in round numbers. The scientists ran this experiment again and again with different scenarios and always got the same result.

Why would this happen? As Janiszewski and Uy explain in the February issue of Psychological Science, people appear to create mental measuring sticks that run in increments away from any opening bid, and the size of the increments depends on the opening bid. That is, if we see a $20 toaster, we might wonder whether it is worth $19 or $18 or $21; we are thinking in round numbers. But if the starting point is $19.95, the mental measuring stick would look different. We might still think it is wrongly priced, but in our minds we are thinking about nickels and dimes instead of dollars, so a fair comeback might be $19.75 or $19.50.

The psychologists decided to check these lab findings in the real world. They looked at five years of real estate sales in Alachua County, Florida, comparing list prices and actual sale prices of homes. They found that sellers who listed their homes more precisely—say $494,500 as opposed to $500,000—consistently got closer to their asking price. Put another way, buyers were less likely to negotiate the price down as far when they encountered a precise asking price. Furthermore, houses listed in round numbers lost more value if they sat on the market for a couple of months. So, bottom line: one way to deal with a buyer’s market may be to pick an exact list price to begin with.

This isn’t all about money, however. Medical information, Janiszew­ski and Uy note, can also be offered in either precise or general terms: a physician might say that your chance of responding to a medication is “good” or that your chance of responding is 80 percent. The percentage is more precise, but many studies have shown that patients prefer vague generalities like “good,” so doctors tend to use them. But remember that life is an auction. In his mind, the patient is dickering with the doctor, so why not negotiate “good” up to “excellent”? When treatment choices are on the line, the auction house can indeed be a perilous place.