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.