Blank Check Companies and Houseful of Investors: Taking a Closer Look at SPACs

By: Rithvik Reddy | rrg5233@psu.edu | October 4, 2020

Let’s start with a trip to a local car dealership. You select a model of your preference and the salesman asks if you would like to buy the model with a standard build that’s ready for you to drive away with or if you would like to custom build your model with accessories and design choices as per your objectives and preferences. To each their own, but you get the idea.

SPAC, abbreviated for Special Purpose Acquisition Company, is a fully registered company with no established business plan or operations (hence the term ‘blank check’) founded by a group of investors or sponsors with expertise in certain business sectors. The goal of such companies is to raise money from an IPO through underwriters, private equity firms and investors and use those funds to pursue deals in acquiring an existing company, called the target company or partner. The money is then required by SEC to be put into a blind trust account while the sponsor of the SPAC has usually two years to search and complete a deal, failing which they would have to liquidate the company. There is no limit on the maximum size of the target company but the minimum size should be roughly 80% of the funds in the SPAC’s trust. Once a SPAC targets, acquires and closes a deal with the partner, it merges with that target company and is listed on a major stock exchange, taking it public. The investors of SPACs then receive shares and/or warrants of the acquired company. Disclosures are minimal as SPACs are at minimum, an aggregated pool of cash without operations and thus belong to a class of companies that have minimal filing requirements.

What happens if the target/partner company is larger in size than the SPAC itself?

Allow me to introduce you to PIPEs. Oddly enough, PIPEs have been around forever and have been in and out of fashion. ‘Private Investments in Public Equities’ are tacked onto SPACs once the sponsors are near to closing a deal with a partner company. At this stage, institutional investors get preferential treatment than retail investors. These institutional investors are informed by the SPAC of a potential acquisition target under confidentiality agreements for them to make a decision on provisioning of further financing for that deal through a PIPE transaction. This preferential treatment costs the institutional investors being barred from trading the shares for a minimum of four months after the merger while retail investors can trade the shares any time.

Are these creative corporate financial products new? No. In fact, SPACs have been around for decades. They were infamous for their association with penny-stock frauds and were mostly unregulated in the 1980s and 1990s. The one major factor that has led to recent interest surge in SPACs from the old days is the protections the investors get through investing in these shell companies. For example, if an investor decides not take shares in the acquired company, they can withdraw their investment fully with interest.

Okay, investors are afforded more protection for their capital than yesteryears. But what do SPACs have in store for companies looking to go public? Why would they opt for a SPAC route to going public than the good ol’ traditional IPO? One of the key advantages is the efficiency to go public. A traditional IPO takes long time and can leave the company exposed to market fluctuation vulnerability compared to a SPAC deal that can be completed in few months. Another advantage is the ability of SPAC to provide financial projections of the target firm like revenue, profits and growth to its investors (banks do not underwrite for these deals due to the liability risks these disclosures could present). These financial projections form the basis of the initial valuation of the target firm, making it seem as a better offer to the investors. This wouldn’t be possible through the traditional IPO route.

While SPACs have come a long way since their ‘Wild West’

years, they are still not vetted as much as traditional IPOs

from regulatory perspective, something that some industry

watchers are concerned about. Investors trusting the SPAC

with their capital do so with little information and no

operating history to base their decisions.

This year alone, 82 SPACs have gone public, which is

almost 40% of the total IPOs this year (which is huge,

compared to around 1.1% a decade ago), raising over $40

billion to date, largely due to the liquidity advantage and

enthusiastic bullish appetite towards new growth or

startup companies with the added volatility in markets due

to the pandemic.

On July 22, 2020, Bill Ackman, CEO of Pershing Square Capital Management took Pershing Square Tontine Holdings Ltd. public, raising $4 billion in what was the largest SPAC IPO till date. Recent such deals include DraftKings which was merged with SPAC Diamond Eagle Acquisition Corp. and SBTech Global earlier this year, Nikola merged with VectoIQ Acquisition in June, Virgin Galactic raised over $480 million through this route after merger with Social Capital Hedosophia last year. Former House Speaker Paul Ryan started his own $300 million SPAC as well as baseball executive Billy Beane has filed for a $500 million SPAC. Potential SPAC deals include Playboy returning to public after almost a decade with a SPAC merger and Amazon backed Ecobee is in talks of merger with Canaccord SPAC.

There’s certainly a lot going on. Let’s take a closer look at SPACs from underwriters and investors perspectives.

Of the group of investors and underwriters for these SPACs, banks refrained from underwriting SPACs due to several risks associated with them. But since the past decade, things have changed with private quite, hedge fund firms and smaller investment banks joining and now major, traditional bulge bracket banks such as Goldman Sachs, Citigroup, Deutsche Bank and Credit Susie among others have started venturing into underwriting SPACs due to the bigger and fee-intensive deals they can grab. How big are the deals? Take this – Goldman Sachs earned $105 million, Citigroup took in $107 million and Credit Suisse, $190 million in fees from these deals.

STEPS INVOLVED IN A SPAC TRANSACTION

Phase 1: SPAC IPO Phase (Roadshow, S-1 Filing, IPO)

Phase 3:

Phase 2: Operational Phase (Target Search, Due Diligence, Negotiation)

IF: No target found for a deal – expiration – SPAC liquidated

IF: Target found – De-SPAC Process

1. Shareholder Approval 2. SEC Review

3. Founder Vote

Requirements

4. Redemption Offer

Next: File “Super 8-K” within 4 business days following De-SPAC transaction completion

Merged entity is then listed

publicly on a major stock

exchange for trading

Investors who are yield hungry see SPACs as safer investment compared to treasuries as they can invest in a SPAC and earn interest till the sponsor finds and closes a deal. And if the investor doesn’t like the deal or the sponsor fails to seal a deal, they can easily liquidate their position with interest earned. This has led to a sudden surge in interest for these blank check firms and investors are paying heavy premiums to buy shares of SPACs that are trading at high prices even before knowing the deal. A recent example is of Apollo Global Management-backed Spartan Energy Acquisition Corp. whose shares spiked 54% due to a potential deal with Fisher Inc., a battery-powered car startup that has no product in the market.

It remains to be seen if this niche equity market has become too much over saturated and speculative.

SPACs are a function of a bull market phenomenon when companies do well and gain popularity. In an optimally diversified portfolio, a well-run SPAC can act like a liquid private equity investment. Most of the companies that the sponsors of SPACs target are from PE/VC portfolios which means they are more mature than a recent startup. Like any good investment an investor decides to put their money in, SPAC investors (especially retail) need to study the sponsors or the management team due to limited or no information on prospective deals.

If you choose to custom build your car, you have to trust your salesman with your money for them to choose the right parts and accessories for your car because when you buy a car, you are also investing in the salesman for a good deal.

Oh, congrats on the new (investment) vehicle, by the way!

Sources:

https://techcrunch.com/2020/08/21/almost-everything-you-need-to-know-about-spacs/ https://www.investopedia.com/terms/s/spac.asp

https://www.wsj.com/articles/why-finance-executives-choose-spacs-a-guide-to-the-ipo-rival-11600828201