Behind the re-emergence of SPACs

The reason why SPACs are back in the news is that they are on a literal death march. A typical SPAC must complete its acquisition within 18 months to 2 years, and so the last remaining survivors of the 2007-crop are fighting to stay alive.

The Wall Street Journal recently noted their reappearance by highlighting the completion of SPAC acquisitions by the GHL Acquisition Corporation, affiliated with Greenhill & Company, and the Hicks Acquisition Company, affiliated with the Texas investor Thomas O Hicks.

The Journal asserted that these transactions were a harbinger of a return to risk and presumably SPACs. Dealscape cast a skeptical eye on this story, noting that this was a two-transaction tale. It also concluded that SPACs were merely dormant during the financial crisis and were returning from the surviving class of 2007 and 2008.

The truth is less rosier than Dealscape puts it. According to SPAC Analytics, of the 161 SPAC initial public offerings since 2003, 72 have acquired targets and 51 have liquidated. This leaves 35 surviving SPACs, of which 15 are still searching for a target.

It is not easy being one of these SPACs. GHL Acquisition only completed its deal after it entered into repurchase agreements over 32% of its shares for the greater of $10.10 or the price per share at which GHL Acquisition common stock are sold in a future public offering. Typically, SPACs liquidate if the acquisition is not approved by a super majority of up to 80% of shareholders.

If 30% of the shares voted against the transaction, it would not occur. The purchase prevented a blocking position from being taken on the acquisition. The cost was the 10 cents a share above the liquidation value of the SPAC, which was set at $10 a share. In addition, Greenhill and its affiliates had to forfeit of 1,441,176 shares and 12.4 million warrants to assure a vote.

These types of maneuvers are not uncommon these days. Last week, the Triplecrown Acquisition Corporation, which is trying to acquire Cullen Agricultural Technologies, announced that it had bought out eight shareholders holding 3.9 million shares. Triplecrown also agreed to pay a commission of up to 1% to a third party in connection with the repurchase of up to 15.2 million additional shares from third parties. Triplecrown’s actions acquired up to 27.6% of its shares at a premium.

These buybacks have made SPACs a hedge-fund dream, because the funds take blocking positions in such acquisitions for easy gains. This can lead to some extreme maneuvers as SPACs try to arrange an acquisition.

Take for example, SP Acquisition Holdings’ proposed acquisition of the Frontier Financial Corporation, a small Washington-state bank. Steel Partners was the primary shareholder and sponsor of SP Acquisition with approximately 19.1% of the shares, and Steel Partners’ founder and chief executive, Warren Lichtenstein, is currently chairman and chief executive of SP Acquisition as well.

The acquisition was terminated October 5 and the SPAC liquidated last week. Before this happened though, SP Acquisition pushed the deal through a number of hoops to complete it. First, it sought shareholder approval to allow it to purchase a target business whose fair market value is below 80% of SP Acqusition’s trust account balance. As is typical for SPACs, SP Acquisition was prohibited from making an acquisition below this level.

Frontier’s current market capitalisation was approximately 13% of SP Acquisition’s trust account balance, thus requiring this approval. SP also sought a shareholder vote to allow the board to raise the permissible number of votes against a proposed acquisition to 30% from 10%.

These steps are a little unusual, but at least they could have been explained by an opportunistic change in SP Acquisitions’ strategy. But as part of this change the proxy statement disclosed: Upon consummation of the merger, SP Acquisition and Messrs. Bergamo, LaBow, Lorber, Toboroff and Walker have agreed to forfeit an aggregate of 9,453,412 shares purchased prior to SPAH’s initial public offering, constituting approximately 17.5% of SPAH’s outstanding shares of common stock as of the record date.

That amounted to giving up $74.6 million (as a share of the trust’s balance) to $91.9 million (as a share of SP Acquisitions’ current market cap). In either case, this was a larger value than the total market cap of the company that SP Acquisition would acquire in this transaction — and possibly the strongest inducement for acquiring shareholders to approve a merger that I have seen. It still did not succeed.

SPACs have been championed for their transparency, liquidity and their put right, which gives shareholders a virtual guarantee that they will receive back the liquidation value of their investment. But I have criticized them for the high compensation paid to management— up to 20% of the equity in the compan– – and for their race to make an acquisition, which allows for holdup and possibly bad acquisition choices and returns. This is validated by SPAC Analytics, which finds that SPACs have markedly trailed the Russell 2000 Index on an annualized return (minus 22.1% for SPACs versus minus 5.3% for the index). SPACs were clearly a boom-time phenomenon and the returns show it. They are a poor man’s private equity, which offers greater management skill and diversification. But if they inexplicably return, investment banks and lawyers should take note of these holdup problems and the race and buyoffs they create. They may also want to create mechanisms to address them, but perhaps I am hoping too much.