Are SPACs here to stay?
Barely a day goes by without another special purpose acquisition company (SPAC) hitting the headlines. 2020 has already smashed the record for the number of SPACs launched in a calendar year, and the amount raised in SPAC IPOs had surpassed the previous 12-month high before the end of June.
With stocks so volatile during the early weeks of the COVID crisis, SPACs were suddenly the hottest story in town. That’s because – alongside the benefits of tapping into brand-name SPAC sponsors’ deep market and/or industry experience – they offer companies a faster and more predictable way to go public. Founders negotiate with the SPAC and its sponsors to lock in the price they’ll receive for the business before registering to become a public company and executing the merger (as compared to a traditional IPO where the company registers first and only then markets and prices its shares, a process that normally takes much longer). The true value of company once it merges with a SPAC is obviously dependant on aftermarket trading, but it’s all but impossible for founders to predict an exit price at the start of an IPO process during times of extreme market uncertainty.
Fast forward to mid-2020 and SPACs remain in full swing, despite the equity markets firing again (albeit with underlying volatility). Whether they stick around may depend on whether more founders follow in the footsteps of Bill Ackman, whose $4bn Pershing Square Tontine was the biggest ever SPAC IPO when it launched in July. The deal was notable because Ackman eschewed the sort of sponsor-friendly equity and warrants package that has historically defined SPAC vehicles, giving the owners of Ackman’s M&A targets more economic reason to consider a merger even though stocks are rising.
Today’s SPACs will also need to perform better than previous iterations if they’re to remain attractive to investors. While there have been some notable recent successes (DraftKings, Clarivate), it cannot be ignored that SPACs’ five-year rate of return to the end of 2019 is a shocking minus 18.8 per cent. Simply investing in the S&P 500 (for example through an ETF) over the same period would have generated a more than 50 per cent return, with LBO and VC funds delivering more than 10 per cent.
Pamela Marcogliese, a capital markets partner in Freshfields’ Silicon Valley office who has advised on some of the biggest recent SPAC deals, says: ‘Boards who are looking to raise equity capital could choose a traditional IPO, a direct listing or a SPAC merger. SPAC deals had historically prevailed when the markets were challenging. But if we start to see terms shift in favour of target companies, they could stay in play, particularly as they present certain advantages over traditional IPOs.’
Sarah Solum, Freshfields’ Silicon Valley managing partner, who, like Pamela, has a long track record advising on equity capital markets deals, adds: ‘With more options available to companies, we’re likely to see more listings. Boards still have to weigh whether going public is the right choice for them, and if so, how they’re going to do it, because each model has different strengths. A traditional IPO might be best for a company looking for support from a syndicate of underwriters and the opportunity to do in-depth education with research analysts. Direct listings appeal to businesses that are confident in their ability to garner attention from investors and analysts, and who place a premium on market-based pricing. SPACs present the advantage of speed to market and valuation certainty. With so many SPACs around right now, boards are getting lots of approaches to do deals.’
SPACs: a primer
SPACs are corporate entities that float on some public markets (they are permitted in New York and London, for example, but not in Hong Kong) to raise money for M&A. They are typically established by deal professionals with a personal brand or are affiliated with investor groups with a track record of success.
They list by issuing ‘units’ consisting of one common share and a whole (or fraction) of a warrant to buy an additional share of the SPAC after a business combination has taken place. Although terms can vary from deal to deal, sponsors typically inject their own capital by buying warrants via a private placement, and also benefit from being able to buy ‘sponsor shares’ (around 20 per cent of the common shares after the IPO) for a nominal fee.
Sometimes, SPAC transactions are accompanied by additional capital from PIPE investors.
In the US, SPACs enable the public to participate in private equity-style transactions safe in the knowledge that if the sponsors are unable to find a target within a set period (typically two years), they get their money back. Even if the SPAC identifies an asset to acquire, public investors can cash out at closing if they choose.
For more on SPACs, read our blog post.
Beware of the SPACtivists
In 2008 – when SPACs were emerging from another golden period – they became a target for activists.
SPAC mergers require shareholder approval, so activists (many with a history of activism in closed-end funds) took to buying shares in SPACs that were trading below the value of their IPO proceeds and voting to block their proposed deals. This would force the SPAC into liquidation, at which point the activist’s stock would convert into a proportionate share of the IPO cash (which is held in a trust account until the merger closes), and they would emerge with a profit. Today’s SPAC structures are evolving to mitigate this risk, with shareholder voting rights modified to make it harder to block deals, the right to vote ‘no’ separated from the right to redeem shares for cash, and restrictions on stockholders selling more than a certain percentage of their shares to guard against activists accumulating large positions.