To the Moon: SPAC Bubble continues in 2021
Grab Holdings recently agreed to merge with SPAC Altimeter Capital Management in a deal that values the Super App around $40 billion.
You have probably heard a little bit about SPAC by now with headlines surrounding the potential IPOs of several Southeast Asia’s unicorns via a SPAC merger. Grab Holdings recently agreed to merge with SPAC Altimeter Capital Management in a deal that values the Super App around $40 billion – the biggest blank-check company deal ever. Meanwhile, following the near return of its performance to Pre-Covid days, Traveloka is discussing a potential merger with SPAC Bridgetown Holdings Ltd, backed by Richard Li and Peter Thiel. You might also be probably aware that many celebrities and star athletes like Shaquille O’Neal, Stephen Curry and Serena Williams have even launched their own SPACs.
This frenzy probably started in 2017 when Chamath Palihapitiya raised $600 million for a SPAC. Called Social Capital Hedosophia Holdings, it was ultimately used to take a 49% stake in the British spaceflight company Virgin Galactic (SPCE). While the stock has now come back down to earth after the market downturn, the stock surged to an intraday high of over $54 in February, which would represent a 500%+ return for those who bought in before the deal was announced and before the merger was completed. Even today's lower current price of around $25 a share is a great return for early investors at 250%.
But how do SPACs come together in the first place, how do they work, should you be investing in one, or better yet, should you be thinking of launching one? Here we highlight almost everything you need to know about SPACs and this hopefully helps to answer your questions.
What Is a SPAC?
Special purpose acquisition company (SPAC) are companies with no commercial operations that are formed specifically to raise capital through an initial public offering (IPO) for the purpose of acquiring existing companies, typically 18-24 months following the consummation of the IPO. The IPO is completed within a significantly compressed timeline usually 2-3 months, as compared with IPOs of traditional companies with operating histories. It is extremely important to note that SPACs cannot identify acquisition targets at the time of their IPO, especially because detailed financial and other information regarding the target company would then be required to be disclosed to potential investors, likely lengthening the time needed to complete the SPAC IPO.
Although they have been around for a while, they have garnered a lot of attention in recent years with big-name underwriters and investors using SPACs to raise a record amount of IPO money. SPAC IPOs raised more than $83 billion across 248 SPACs in 2020, up from just over $13.5 billion across 59 SPACs in all of 2019 and a mere $3.5 billion across 13 SPACs in 2016. And this is only the beginning – 2021 saw 300+ SPAC IPOs in its first quarter alone.
The novelty of the SPAC model is that it has successfully addressed the need for permanent capital solution for sponsors, price and liquidity certainty for sellers of targets (typically venture capital and private equity companies looking for exit opportunities), and the public investors’ ability to make leveraged buyout type investment in a professionally managed target. In addition, stock exchange companies have been seeing a dramatic decline in public companies and since they make money by bringing companies public, they too benefit from SPACs.
SPAC Lifecycle
The following illustration refers to the typical lifecycle of SPACs listed in the US.
Formation
SPACs are generally formed by investors, or sponsors, with expertise in a particular industry or business sector, with the intention of pursuing deals in that area. The entity type and jurisdiction of formation of a SPAC is driven by accounting, tax, and corporate law considerations. US-listed SPACs can be either incorporated as domestic corporations or formed in foreign jurisdictions. They are initially capitalized by contribution of nominal capital by sponsors in exchange for founder shares, which typically constitute of 20% of the SPAC ownership post IPO (the promote) and are subject to anti-dilution adjustments.
However, recent SPAC IPOs suggest that sponsors are increasingly agreeing to a smaller percentage of promote. In fact, Pershing Square TH Sponsor, LLC did not take any founder shares from its SPAC Pershing Square Tontine Holdings, Ltd. The absence of any promote in the Pershing Square Tontine Holdings, Ltd. transaction is a game changer for sponsor economics since it has less dilutive impact on the public shareholders of the SPAC as compared to other blank check companies, and, as such, makes the SPAC more attractive to and better aligned with the public shareholders and potential merger partners.
IPO
Once capitalized, the SPAC files to register the shares that will be sold to the public in the IPO. The SPAC will then go through a review process with the SEC and clear SEC comments, following which the SPAC will undertake a road show and close on a firm commitment underwriting. Because a SPAC is registered with the SEC and is a publicly traded company, the public can buy its shares before the merger or acquisition takes place. As such, they are often referred to as the 'poor man's private equity funds.’
A SPAC must meet the applicable stock exchange listing standards both at the time of the IPO and the de-SPACing transaction. A SPAC typically lists its securities on either NASDAQ or NYSE, which has similar listing standards with a few exceptions. Notably, NYSE prescribes a higher threshold for market value of listed securities, $100 million, which is twice the size prescribed by NASDAQ at $50 million.
As a shell company with no operating history and simplified financial statements, the SPAC registration statement focuses more on the management team and the securities being sold, as compared to the more involved and comprehensive disclosures for companies with operating histories. A SPAC will also disclose in its registration statement whether the entity will focus on a particular industry, geography, or sector, or it may retain the flexibility to pursue a transaction of any kind.
The equity sold in a SPAC IPO consists of “units.” They are typically $10 a unit, except for rare occasions such as with hedge fund billionaire Bill Ackman’s Pershing Square Capital Management, which launched a $4 billion SPAC that sold units for $20 each. Usually, a unit comprises one share of common stock and either a whole or a fractional warrant, which is a security that entitles the holder to buy more stock of the issuing company at a fixed price at a later date that acts a sweetener for prospective buyers. The warrants are typically detachable and trade separately from the shares.
The proceeds from the IPO are placed in a trust as the SPAC begins identifying potential operating targets for acquisition. It typically has 18 to 24 months to complete the acquisition, but some SPACS include a mechanism by which stockholders can vote to extend the timeline. If an acquisition is not consummated prior to the outside date, the SPAC dissolves and returns the proceeds in the trust back to the investors. The founder shares are not entitled to any liquidating distributions.
Identification of Target and Transaction Size
After the IPO, the SPAC identifies acquisition opportunities and negotiates the de-SPAC transaction. It simultaneously begins its due diligence on the potential target or targets – a comprehensive M&A review that includes, among others:
conducting legal, business, financial, tax, and HR diligence
producing and validating financial reports
studying product, industry, and market potential
preparing market research reports
conducting background checks on relevant stakeholders
obtaining a fairness opinion in connection with the de-SPAC transaction
While the size of the acquisition cannot be less than approximately 80% of the IPO proceeds in the trust account, it is often in the range of two to four times the IPO size. There is no maximum limit for the purchase price for acquiring a target and if the target is larger than the SPAC itself, they would then look to PIPE (Private Investments in Public Equities) deals.
De-SPAC Transaction Structure
A successful SPAC IPO really accomplishes nothing from the perspective of the management team and the sponsor unless it is followed by a successful de-SPACing. The de-SPAC transaction may be structured as a merger or purchase of assets or stock. A reverse triangular merger is a more favorable choice due to reduction of costs related to assignment of contracts, governmental permits, and third-party consents as compared to an asset sale or forward merger. The sellers of the target may receive cash or SPAC equity or a combination of both.
Significant negotiations revolve around sponsor economics, such as dilution of promote, criteria for forfeiture of founder shares, earn-out criteria, milestones for earn-out shares issued to sponsors or stockholders, and post-closing capitalization of the combined company to name a few. In addition, the de-SPAC transaction agreement contains customary representations, warranties, conditions, and covenants that include obtaining regulatory approvals, necessary third-party consents, and SPAC's stockholder consent, if applicable, for approving the de-SPAC transaction. Some SPAC-specific conditions may include minimum thresholds to be maintained in the trust account after the stockholders have exercised their redemption rights and availability of additional funding and credit arrangements.
In advance of signing a de-SPAC transaction agreement, the SPAC may opt to arrange committed debt or equity financing, such as a private investment in public equity (PIPE) commitment, to finance a portion of the purchase price for the business or enters a contingent-forward contract—typically with an affiliate of a sponsor—or debt arrangements to backstop any shortfall caused by stockholders exercising redemption. The financing is contingent upon closing of the de-SPAC transaction.
De-SPAC Transaction Process
Before the SPAC can close on a de-SPAC transaction, the public stockholders of a SPAC have the right to return their shares (also known as the redemption right) in exchange for the pro rata amount applicable to such shares held in the SPAC's trust account (which is roughly equal to the IPO share price). The redemption right is offered to the public stockholders either in the proxy statement soliciting approval for the de-SPAC transaction or through a tender offer process.
Stockholder approval will be required in the event the SPAC is not the surviving entity in the merger, if changes to the SPAC charter are required, such as reincorporation in another jurisdiction, or if equity equal to or more than 20% of a SPAC's then outstanding voting stock is issued in the de-SPAC transaction.
When stockholder approval is required, the SPAC files a proxy statement for the transaction that includes, among other things, a proposal for approval of the de-SPAC transaction and an offer to redeem the shares of its stockholders. The proposal and offer are independent, meaning a stockholder may vote in favor of the de-SPAC transaction and also accept the offer to redeem its shares. By contrast, the sponsors typically do not have the ability to redeem their shares since they agree in advance to vote their shares in favor of the de-SPAC transaction. Where a stockholder approval is not mandatory, the SPAC undertakes a tender offer process, offering the redemption right to the stockholders.
Post-Transaction Requirements
Upon the closing of the de-SPAC transaction, the combined company becomes a publicly traded company responsible for complying with the reporting and other requirements under applicable securities laws. Many combined companies file their registration statements on Form S-3 to register shares issuable upon the exercise of the warrant or any other private shares. However, as a former shell company, a combined company can qualify for the use of Form S-3 only after 12 months have elapsed since the date of de-SPACing.
Also, the combined company is prohibited from qualifying as a well-known seasoned issuer (WKSI) for at least three years following a change in shell company status. In other words, until the combined company qualifies as a WKSI, any shelf registration statement filed on Form S-3 would not be automatically effective, as it would for WKSIs, and will be subject to SEC review before it can be declared effective.
Within four days after closing the de-SPAC transaction, the combined company files a Form 8-K, also known as a “Super 8-K,” disclosing, among other things, the de-SPAC transaction, financial statements, updated to reflect actual redemptions and other updates, and other items typically required by a company in a Form 10 registration.
What’s next?
Today, there are more than 550 active SPACs with around $180 billion of equity held in trust seeking acquisitions. Given that most de-SPAC transactions tend to be in the range of two to four times the proceeds raised in a SPAC IPO, there is $360 to $720 billion of SPAC-related capital available to be deployed in the M&A market – needless to say, this is a huge number. And we are only talking about the US as most SPACs are still floating in New York. In Britain, a government-backed review called for reforms to London’s listings regime to allow for SPACs that are structured similarly to those in New York. Singapore Exchange is also reportedly also working toward listing special purpose acquisition companies as early as 2021.
In addition, over the last decade, the SPACs have increased in size at a steady clip. In 2020, the average SPAC IPO size is north of $400 million as compared to a mere $50 million in 2010. With repeat sponsors and enhanced participation of established managers and private equity players to sponsor SPACs, there also has been increased willingness among sellers of targets to go public via the SPAC route. As a result, the quality and performance of companies going public via SPACs have grown tremendously in the last few years. A few recent examples include Diamond Eagle Acquisition Corp's acquisition of DraftKing (DKNG) and Nebula Acquisition Corp.’s acquisition of Open Lending (LPRO) – both has showed strong returns and yet the market maintains an “outperform” status on the stock of these companies.
However, the boom in blank-check firms, shell companies seeking to merge with private companies with the intention of taking them public, has drawn the scrutiny from regulators who are growing increasingly concerned about the risks these investment vehicles pose, especially to retail investors.
There is more and more evidence on the risk side of the equation for SPACs as studies have shown SPACs performances not matching the hype surrounding them. SPAC investing has been less profitable for individual investors as most SPACs generally underperform the stock market and eventually fall below the IPO price. Acting SEC Chair Allison Herren Lee warned investors of investing in blank-check firms and the SEC later released an investor alert that specifically warned of the risks involved with celebrity-backed SPACs after numerous cases show investors betting on certain SPACs primarily due to celebrity’s involvement.
The boom in SPACs has allowed a significant number of zero-revenue companies to list with unprecedented valuations, providing ample exit opportunities for private equity investors and unicorns. But with the rampant speculation of the public market, is this really the right solution for the market or are we simply repeating that of the dot-com era?