NEW YORK and TORONTO — They have no assets to scrutinize, and no financial records to scour.
Many of them can't even tell you what sort of business they'll be dabbling in a month from now – if any at all. And yet special purpose acquisition companies, a niche product once confined to the shadows of the market, are suddenly among the hottest products on Wall Street, dominating an otherwise abysmal year for new stock listings.
SPACs, or “blank-cheque companies,” as they are often called, accounted for almost one-quarter of all U.S. initial public offerings last year, and raised a total of $12-billion (U.S.) in proceeds. So far in 2008, they have comprised half of America's IPOs, raking in $3.4-billion from investors – far more than conventional IPOs when the distorting effect of Visa's record offering in February is excluded. And with their popularity rocketing, some deal makers now expect SPACs to begin recruiting Canadian entrepreneur who could sponsor a SPAC offering.
“If you don't include Visa, SPACs have dominated the equity IPO markets in the U.S. this year,” said Tina Pappas, a managing director and SPAC specialist at boutique investment banking firm Morgan Joseph. “It has proved to be more robust than the overall stock market.”
SPACs may sound arcane, but the structure is pretty straightforward. A company with no operational history raises money from investors in an initial public offering and in turn promises to make an acquisition – often in an undisclosed industry – within the next two years. The IPO amounts to what is essentially a bet on the strength of a management team, raising a rather obvious question: why would investors, already shaken by a toxic cocktail of economic conditions, be so willing to write a blank cheque to an unproven business venture?
Part of the answer resides in the structure of the IPO. The proceeds from the offering are placed into a trust account, and shareholders are given a chance to approve any deal. Typically, if more than 20 per cent vote against it, the deal is nixed, and most of the money is returned.
“These SPACs provide upside [options] with limited downside risk,” explained Bill Haddad, a lawyer with DLA Piper LLP, who has worked on a half dozen such deals. “At the end of the day, a guy can vote ‘no' and get his money out of the trust.”
SPACs have been around for decades, but did not gravitate toward the mainstream until a few years ago when major brokerage firms spotted them as a new source of fees. Their entry paved the way for bigger deals, in turn luring more institutional investors into the fold. At the same time, the recent credit crunch has made it difficult for private equity players to borrow money for acquisitions.
SPACs are viewed by many as something of a hybrid: they can tap the public markets for cash, allowing smaller institutions and retail investors to participate in a private-equity model that would have been closed to them in the past.
And for sponsors, these structures offer the potential of an easy exit strategy (they can sell their shares) along with a hefty payday if they are successful. (Sponsors typically buy about 3 per cent of the IPO, but often receive 20 per cent of the equity of the company once an acquisition is made.)
Several high-profile names have entered the space in the past year, including leveraged buyout titan Thomas Hicks (Brian Mulroney sits on his SPAC board), billionaire Ronald Perelman, and Nelson Peltz, the fast-food mogul, all of which have helped to legitimize the sector.
“The quality of the sponsors of SPACs has improved,” said David Spivak, a managing director at Citigroup, which has been a leader in the field.
“It is initially a blind pool, but you want to feel comfortable and ideally you want people who have made money for investors before – people with good track records.”
Jamba Juice, American Apparel, and British hedge fund GLG Partners LP are among some of the more high-profile companies to be acquired by SPACs.
Yet Mr. Spivak, like many professionals who work in the sector, acknowledge the results have been mixed. Some SPACs have performed very well, while others, like Acquicor, the brainchild of former Apple executives Steve Wozniak and Gil Amelio, have foundered. There may be downside protection before a deal is announced, but once it is – and if it's bad – investors will still suffer.
Since 2003, the 48 SPACs that have made an acquisition have returned minus 11 per cent to investors, while the 72 looking for a deal have returned minus 3 per cent, according to figures compiled by SPAC Analytics.
Not impressive, exactly, but SPAC Analytics founder Neil Danics cautions against reading too much into the numbers, considering that equity markets have tanked in the past year.
“It's very difficult to get anyone excited about a company going public now,” he said. “The philosophy of making an investment where it's hedged by cash and you have the upside of a good acquisition, I think it's here to stay.”
So far SPACs have had a low profile in Canada, but that may be about to change. Tailwind Financial Inc. is the only major SPAC in Canada, raising $100-million (U.S.) last year to go hunting for deals in the financial sector. The firm found one – it signed a deal in January to combine with a New York-based asset management company, although it has not yet been approved – and its principals are looking for opportunities in other sectors.
“SPACs have been successful historically in areas where hedge funds don't have the depth of research, in more specialized markets,” said Tailwind chief executive officer Andrew McKay, who has been talking to management teams about collaborating on an energy-related SPAC. He added that the oil patch “is a logical place for Canadian involvement.”
“It goes back to these investor groups looking for specialists in particular sectors, and that's an area we're looking at.”
According to Dealogic, a further $12.9-billion worth of SPACs are in the pipeline, accounting for the vast bulk of pending IPOs this year. But in the past few weeks, activity has noticeably slowed.
Part of the blame can be laid at the claws of the bear market. And part is a result of the structure's newfound popularity. As bigger and bigger deals have emerged – one SPAC worth more than $1-billion was launched in December – disposable cash has dwindled, and investors are now waiting to see how some of these supersized SPACs do before committing more money.
“There's been a lot of capital put to work, and I think they're wanting to see how these acquisitions work out,” Mr. Spivak said.
“It's not a mainstream investment yet.”
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