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Investing in Blank Checks (w/ John Jannarone) - Trade Ideas
A special purpose acquisition company (SPAC) is a type of investment fund that allows public stock market investors to invest in private equity type transactions, particularly leveraged buyouts. SPACs are shell or blank-check companies that have no operations but go public with the intention of merging with or acquiring a company with the proceeds of the SPAC's initial public offering (IPO).
Blank check company ipo
In the early 2000s, SPACs were typically sold via an initial public offering (IPO) in $6 units consisting of one common share and two "in the money" warrants to purchase common shares at $5 a common share at a future date usually within four years of the offering. Today, a new generation of SPAC offerings are more commonly sold in $10 units which consist of one common share and an out of the money warrant or fraction thereof.
SPACs trade as units and/or as separate common shares and warrants on the Nasdaq and New York Stock Exchange (as of 2008) once the public offering has been declared effective by the U.S. Securities and Exchange Commission (SEC), distinguishing the SPAC from a blank check company formed under SEC Rule 419. Trading liquidity of the SPAC's securities provide investors with a flexible exit strategy.
In addition, the public currency enhances the position of the SPAC when negotiating a business combination with a potential merger or acquisition target. The common share price must be added to the trading price of the warrants to get an accurate picture of the SPAC's performance.
By market convention, 85% to 100% of the proceeds raised in the IPO for the SPAC are held in trust to be used at a later date for the merger or acquisition.
A SPAC's trust account can only be accessed in order to fund a shareholder-approved business combination or to return capital to public shareholders at a charter extension or business combination approval meeting. Today, the percentage of gross proceeds held in trust pending consummation of a business combination has increased to 100% and more.
Each SPAC has its own liquidation window within which it must complete a merger or an acquisition. Otherwise it will be forced to dissolve and return the assets held in the trust to the public stockholders. In practice, SPAC sponsors can often extend the life of a SPAC by making a contribution to the trust account in order to entice shareholders to vote in favor of a charter amendment delaying the liquidation date.
In addition, the target of the acquisition must have a fair market value that is equal to at least 80% of the SPAC's net assets at the time of acquisition.
Previous SPAC structures required a positive shareholder vote by 80% of the SPAC's public shareholders in order for the transaction to be consummated. However, current SPAC provisions do not require a shareholder vote for the transaction to be consummated unless as follows:
Type of transaction & Shareholder approved required
- Purchase of assets..........................................................................................No
- Purchase of stock of target not involving a merger with the company..........No
- Merger of target with a subsidiary of the company.......................................No
- Merger of the company with a target............................................................Yes
In order to allow stockholders of the SPAC to make an informed decision on whether they wish to approve the business combination, full disclosure of the target business, including complete audited financials for it, and terms of the proposed business combination via an SEC merger proxy statement is provided to all stockholders.
All common share stockholders of the SPAC are granted voting rights at a shareholder meeting to approve or reject the proposed business combination. A number of SPACs have also been placed on the London Stock Exchange AIM exchange; these SPACs do not have the aforementioned voting thresholds.
Since the financial crisis, protections for common shareholders have been put in place allowing stockholders to vote in favor of a deal and still redeem their shares for a pro-rata share of the trust account.
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(This is significantly different from the blind pool - blank check companies of the 1980s, which were a form of limited partnership that did not specify what investment opportunities the company plans to pursue.) The assets of the trust are only released if a business combination is approved by the voting shareholders, or a business combination is not consummated within the amount of time allowed by a company's articles of incorporation.
The SPAC is usually led by an experienced management team composed of three or more members with prior private equity, mergers and acquisitions and/or operating experience.
The management team of a SPAC typically receives 20% of the equity in the vehicle at the time of offering, exclusive of the value of the warrants. The equity is usually held in escrow for 2–3 years and management normally agrees to purchase warrants or units from the company in a private placement immediately prior to the offering. The proceeds from this sponsor investment (usually equal to between 2% to 8% of the amount being raised in the public offering) are placed in the trust and distributed to public stockholders in the event of liquidation.
No salaries, finder's fees or other cash compensation are paid to the management team prior to the business combination and the management team does not participate in a liquidating distribution if it fails to consummate a successful business combination.
Blank-Check Companies, a Hot IPO Fad, Contain Pitfalls for Investors
In many cases, management teams agrees to pay for the expenses in excess of the trusts if there is a liquidation of the SPAC because no target has been found. Conflicts of interest are minimized within the SPAC structure because all management teams agree to offer suitable prospective target businesses to the SPAC before any other acquisition fund, subject to pre-existing fiduciary duties.
The SPAC is further prohibited from consummating a business combination with any entity which is affiliated with an insider, unless a fairness opinion from an independent investment banking firm states that the combination is fair to the shareholders.
I-Bankers Securities Inc. has participated in 104 SPAC IPOs as an (co-)underwriter since 2003 and 10 deals in 2019, more than any other bank. In recent years, bulge bracket banks have started participating in more SPAC IPOs, with Cantor Fitzgerald & Co.
and Deutsche Bank Securities Inc. on the cover of 30 SPAC IPOs from 2015 through August 2019. Citigroup, Credit Suisse, Goldman Sachs, and BofA have all built a significant SPAC practice, while Cantor Fitzgerald led all SPAC underwriters in 2019 by book-running 9 SPACs which raised over $2.15bn in IPO proceeds.
Since 2018 the top five law firms with SPAC IPO legal assignments are Ellenoff Grossman & Schole, Skadden, Arps, Slate, Meagher & Flom, Graubard Miller, Winston & Strawn, and Kirkland & Ellis.
SPACs in Europe
In July 2007, Pan-European Hotel Acquisition Company N.V.
was the first SPAC offering listed on the Euronext Amsterdam exchange, raising approximately €115 million. I-Bankers Securities has been the underwriter with CRT Capital Group as lead-underwriter. That listing on NYSE Euronext (Amsterdam) was followed by Liberty International Acquisition Company, raising €600 mln in January 2008.
Liberty is the third largest SPAC in the world and the largest outside the U.S.A. The first German SPAC was Germany1 Acquisition Ltd which raised $437.2 million at Euronext Amsterdam with Deutsche Bank and I-Bankers Securities as underwriters.Loyens & Loeff served as legal counsels in The Netherlands
SPACs in emerging markets
Emerging market focused SPACs, particularly those seeking to consummate a business combination in China, have been incorporating a 30/36 month timeline to account for the additional time that it has taken previous similar entities to successfully close their business combinations.
Blank-check company Greenrose Acquisition files for IPO with plans to target cannabis sector
Since the 1990s, SPACs have existed in the technology, healthcare, logistics, media, retail and telecommunications industries after investment bank, GKN Securities, specifically founders David Nussbaum, Roger Gladstone and Robert Gladstone, who later founded EarlyBirdCapital with Steve Levine and David Miller, currently managing partner of Graubard Miller law firm who developed the template.
However, since 2003, when SPACs experienced their most recent resurgence, SPAC public offerings have sprung up in a myriad of industries such as the public sector, mainly looking to consummate deals in homeland security and government contracting markets, consumer goods, energy, energy & construction, financial services, services, media, sports & entertainment and in high growth emerging markets such as China and India.
In 2003, the lack of opportunities for mid-market public investors to "back" experienced managers combined with the trend of upsizing private equity funds pushed entrepreneurs to directly seek alternative means of securing equity capital and growth financing.
At the same time, the rapid growth of hedge funds and assets under management and the lack of compelling returns available in traditional asset classes led institutional investors to popularize the SPAC structure given its relatively attractive risk reward profile. SEC governance of the SPAC structure and the increased involvement of the bulge bracket investment banking firms such as Citigroup, Merrill Lynch and Deutsche Bank has further served to legitimize this product and perhaps a greater sense that this technique will be useful over the long term.
SPACs are forming in many different industries and are also being used for companies that wish to go public but otherwise cannot. They are also used in areas where financing is scarce.
Some SPACs go public with a target industry in mind while others do not have preset criteria. With SPACs, investors are betting on management's ability to succeed. SPACs compete directly with the private equity groups and strategic buyers for acquisition candidates.
The tightening of competition between these three groups could result in a bid for the best company and possibly increase valuations.
SPAC IPOs have seen resurgent interest since 2014, with increasing amounts of capital flowing into the concept:
- 2014: $1.8bn across 12 SPAC IPOs
- 2015: $3.9bn across 20 SPAC IPOs
- 2016: $3.5bn across 13 SPAC IPOs
- 2017: $10.1bn across 34 SPAC IPOs
- 2018: $10.7bn across 46 SPAC IPOs
The success of SPACs in building equity value for their shareholders has drawn interest from eminent investors such as Bill Ackman who has backed 3 SPACs till date including the SPAC that took Burger King public.
Private Equity funds like TPG, Riverstone, THL and others have sponsored SPACs in recent years as their popularity has increased.
By virtue of being public companies, SPAC may be targeted by short sellers or "Greenmail" investors. Typically, short sellers have not been very active in SPACs since the stock price remains fairly steady unless there is a transaction announced.
Most SPAC shares are held by large hedge funds and institutional investors who do not actively trade the stock until after the closure of the initial business combination. Recent SPACs have incorporated provisions preventing public shareholders, either acting alone or in concert, from being able to exercise redemption rights in excess of 20% shareholding in order to compel the executive management in any respect.
SPACs and reverse mergers
A SPAC is similar to a reverse merger.
However, unlike reverse mergers, SPACs come with a clean public shell company, better economics for the management teams and sponsors, certainty of financing/growth capital in place - except in the case where shareholders do not approve an acquisition, a built-in institutional investor base and an experienced management team.
SPACs are essentially set up with a clean slate where the management team searches for a target to acquire. This is contrary to pre-existing companies in reverse mergers.
SPACs typically raise more money than reverse mergers at the time of their IPO.
The average SPAC IPO in 2018 raised approximately $234 million compared to $5.24 million raised through reverse mergers in the months immediately preceding and following the completion of their IPOs.
SPACs also raise money faster than private equity funds. The liquidity of SPACs also attracts more investors as they are offered in the open market.
Hedge funds and investment banks are very interested in SPACs because the risk factors seem to be lower than standard reverse mergers.
SPACs allow the targeted company's management to continue running the business, sit on the board of directors and benefit from future growth or upside as the business continues to expand and grow with the public company structure and access to expansion capital.
The management team members of the SPAC will typically take seats on the board of directors and continue to add value to the firm as advisors or liaisons to the company's investors. After the completion of a transaction, the company usually retains the target name and registers to trade on the NASDAQ or the New York Stock Exchange.
In the United States, the SPAC public offering structure is governed by the Securities and Exchange Commission (SEC).
A public offering for a SPAC is typically filed with the SEC under an S-1 registration statement (or an F-1 for a foreign private issuer) and is classified by the SEC under SIC code 6770 - Blank Checks.
Full disclosure of the SPAC structure, target industries or geographic regions, management team biographies, share ownership, potential conflicts of interest and risk factors are standard topics included in the S-1 registration statement.
It is believed that the SEC has studied SPACs to determine whether they require special regulations to ensure that these vehicles are not abused like blind pool trusts and blank-check corporations have been over the years. Many believe that SPACs do have corporate governance mechanisms in place to protect shareholders.
SPACs listed on the American Stock Exchange are required to be Sarbanes-Oxley compliant at the time of the offering including such mandatory requirements as a majority of the board of directors being independent and audit and compensation committees.
Compared to private equity funds that provide investors access to special situations or geographies that they would otherwise not be able to access:
(1) Liquidity: capital committed to PE funds is typically locked up for 7–9 years.
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PE funds invest capital in private companies with no assurance of eventual liquidity through a sale or IPO of their securities. Since the exit event is 4–5 years away, PE funds are exposed to significant market risk for liquidity.
They are also exposed to currency depreciation over lengthy periods of time.
In comparison, SPAC IPO units are liquid and can be freely traded on the Exchange.
(2) Capital management: PE funds draw capital as needed while requiring their Limited Partners to commit to a fixed investment amount over a 5-7 year period.
During this period, the onus of managing the capital is on the Limited Partner.
As a result, unless the Limited Partner can effectively manage the committed but un-deployed capital the IRR of their investment can vary.
In comparison, SPACs escrow the committed capital instead of calling it as needed. This starts the "IRR clock" from the IPO for the SPAC management team.
(3) Management fees: investors in PE funds typically pay 2% annual management fees irrespective of the amount of capital actually invested by the PE fund. Over the life of the PE fund, this can amount to 14%.
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Management fees are also payable after the life of the fund if there are unexited holdings on the assets still invested. Additionally, 20% of the realized profits are paid as "management carry" to the PE fund to incentivize them to produce high returns.
In comparison, SPAC management teams are paid no cash compensation. The SPAC Founder(s) and the Sponsor capital is at risk until an initial business combination is closed.
If a business combination is effected then the SPAC Management Team receives 18% of shares as compensation. These shares are locked up for 12 months after the first transaction to ensure that the SPAC Management Team is focused on long-term value creation. Half these shares can be sold before the 12-month lock-up deadline if the SPAC's share price rises by 25% over the IPO price.
What Is a Blank-Check Company?
(4) Transparency of team/investments: PE funds can pursue transactions as per the discretion of the Investment Committee. The PE Funds investors cannot choose to ignore a capital call if they are not interested in a particular investment. The LP interests in a PE fund are not liquid, there is no ready market for them and they tend to be typically valued at a discount to par given the initial "J-curve" of the IRR curve.
The composition of the PE team is subject to diligence by the LPs. While there are key man provisions relating to change of certain personnel, the PE fund is free to change investment personnel without consent of the LPs.
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SPAC investors hold liquid securities. They can sell their shares if they are not interested in exposure to the acquired entity. The SPAC management team undergoes scrutiny as part of the IPO process with disclosures around their career history and any criminal or civil legal issues. They are also subject to information disclosure obligations as per applicable Exchange regulations.
Other than the risks normally associated with IPOs, SPACs’ public shareholders' risks may include:
- limited liquidity of their securities until the close of the initial business combination.
After the SPAC has acquired an operating company, the liquidity of the equity shares is similar to other listed companies of similar size.
- low visibility on future acquisition(s) at the time of the SPAC public offering.
- dilution due to founder shares (18-20%)
- potential for uncertainty associated with the SEC merger/acquisition proxy process
There is also potential for delay and expense attributable to the public shareholders' special rights and the costs of functioning as a registered public company.
Since 2004, approximately $49.14 billion has been raised across 332 SPAC IPOs in the United States. 2018 was the largest year for SPAC issuance since 2007, with 46 SPAC IPOs raising approximately $10.74 billion. SPACs seeking an acquisition in the energy sector raised $1.4bn in 2018, after raising a record $3.9bn in 2017. NASDAQ was the most common listing exchange for SPACs in 2018, with 34 SPACs raising $6.4bn.
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GS Acquisition Holdings Corp. and Churchill Capital Corp. raised the largest SPACs of 2018, with $690mm each in IPO proceeds.