The Resurgence of Special Purpose Acquisition Companies
Special purpose acquisition companies (SPACs), also known as “cash shells” or “blank check” companies, have once again become extremely popular on Wall Street. The New York Stock Exchange has recently started to accommodate blank check companies, while NASDAQ listed its 100th SPAC IPO in February 2018.
Before I continue with the recent resurgence in SPACs, allow me to provide some background. A SPAC is very similar to a reverse merger. Its management team may focus on a specific industry or take a more generic approach when selecting prospective companies. SPACs are created to raise money through an IPO in hopes of completing an acquisition of private operating companies. Led by experienced investors or management teams, a SPAC is formed when its founders invest initial capital; the founders of the SPAC then sell its shares for nominal value. The money raised through the IPO is initially held in escrow and can only be used to fund the purchase of an operating company. The IPO consists of units, composed of shares and warrants. At this time, the SPAC has no tangible assets on its balance sheet. In a case where a SPAC fails to complete an acquisition by a specific deadline (typically 1-2 years), it is forced to return its funds to its investors.
The more than two-decade old investment strategy experienced a recent surge since its high in 2007 when SPACs accounted for over 21% of all IPOs. Stronger market conditions since the 2016 US Presidential Election have paved the way for new fundraisers in equity markets. Today, Wall Street is witnessing a newfound interest in using SPACs to bring private companies public. In 2017 alone, 34 different SPACs were listed on a US stock exchange, raising close to $10 billion in their IPO’s, the most since before the financial crisis. While many SPACs specialize in certain industries such as oil, gas, and technology, others use different strategies to uncover what they hope to be the next big company.
The volatile method of acquiring companies through SPACs started in the 1990’s and since then, has experienced years of growth and decline.
A few notable companies that were acquired through SPACs are Jamba Juice, which was acquired by Services Acquisition Corporation for $265 million, and American Apparel which was acquired by Endeavor Acquisition for $385 million.
In 2011, Bill Ackman, founder and CEO of Pershing Square Capital Management, invested $500 million in a SPAC which eventually brought Burger King public. Other prominent hedge funds that have invested in blank check companies are Apollo Management, lead by Leon Black, and AQR Capital Management lead by Cliff Asness.
In fact, AQR recently invested in six different SPACs, disclosing a 6.27% stake in Tiberius Acquisition Corporation, a blank check company who recently IPO’d at $150 Million. AQR’s Diversified Arbitrage Fund, led by Ronen Israel, uses a Sub-Adviser to allocate their assets via different alternative investment strategies, in order to maximize their returns.
The fund summary mentions some of the risks involved with investing in a SPAC. One main risk is the potential for extreme volatility, depending on what industry or region your SPAC pursues an acquisition. In addition, you may run into different resale restrictions which arise when dealing with illiquid, over the counter companies.
While investing in a SPAC definitely has its risks, there are many benefits that come along with your investment. SPACs can be extremely useful for companies that are not able to execute a normal IPO. Companies interested in going public that are small or do not have any future growth, may not be in an attractive position to execute a successful IPO. When the IPO process becomes too difficult for companies in more difficult situations, they can look to get acquired by a SPAC that is already public. In addition, going public through SPACs allows you to avoid the hefty bank fees and underwriting discounts required in a normal IPO. When a SPAC merges with its target company, the process for the target is much less dependent on current market conditions and allows for a quicker route to the public market.
As private equity firms and hedge funds continue to invest in SPACs and interest rates continue to increase only marginally, I believe that SPACs will continue its popularity and experience an even-greater increase throughout the rest of 2018. Then again, no one knows what the future holds, so keep in mind that before you invest SPACs to understand all of the risks.