Though a bit dated, the following article appeared in the November 2005 edition of the European Venture Capital Journal. The article is riddled with errors, some minor, some major. It erroneously credits Sunrise Securities for the rebirth of blank check IPOs in the U.S. It was actually EarlyBirdCapital that initiated the current round of offerings. It also identifies Angeliki Frangou as the current Chairman of both Navios Maritime and International Shipping. In reality, International Shipping acquired Navios Maritime.
SPAC to the future
Tom Allchorne
Nov 1, 2005
The first two to have launched in Europe, on the London Stock Exchange’s Alternative Investment Market (AIM), are International Metal Enterprises, which plans to make investments in the global metals and mining industry, and Energy XXI, which is to invest in the oil and gas industry. A third, IRF European Finance Investments, is road-showing at the moment and aims to invest in the financial services industry in Europe, focusing on credit institutions and insurance companies in Greece, Bulgaria, Romania and Turkey. A fourth, unnamed, SPAC is also due before year-end.
Public private equity
With a SPAC, approximately 92% of the cash raised is placed in an inviolable trust with for example JP Morgan, or a similar institution, earning interest. The balance is held for transaction costs (search, due diligence, legal fees etc.). Investors buy units, which consist of one share of common stock and two warrants, and the management is required to make a personal investment in the vehicle. Management has to complete a deal the shareholders approve within 18 to 24 months or the SPAC is liquidated and the cash returned to shareholders. The management team initially holds a 20% equity stake, equivalent to 7.5% on a fully diluted basis if the warrants are exercised. The management cannot sell their shares for three years and must indemnify the trust from liability until a transaction occurs. “They are like a private equity fund with a built-in exit,” says Wayne Rapozo, partner at Weil, Gotshal & Manges.
For investors, SPACs have a range of positives: they are transparent, they allow access to deals normally only available to private equity funds, there’s no cash compensation to the management team of the SPAC, the management team consists of people with experience in the industry the SPAC is looking to invest, and there is only limited risk since shareholders have to vote before every acquisition is completed. If 20% or more of the shareholders vote against the purchase, it doesn’t happen. If less than 20% vote, the investment is completed but the dissenting shareholders have the right to withdraw from the SPAC, and receive liquidation preference to the amount held on the SPAC’s trust account plus any remaining assets. SPACs are also flexible for investors. A shareholder has three options: it can hold shares and warrants for maximum involvement; hold the shares but fund some of the investment by selling one or both of the warrants per unit; or sell the shares but maintain upside optionally by retaining the warrants. An investor’s downside is limited to a maximum of 8% of their investment until an acquisition occurs, and, after an acquisition is completed, the shares should trade at a premium to cash, in relation to market multiples for the acquired company’s sector, and the warrants should trade at a significant premium. This liquidity combined with downside protection has been called “public ‘private equity’”. Piers Linney, CEO at Tower Gate Capital, says: “Material alternative sources of investment are seeking access to private equity-style transactions, but they often require liquidity. SPACs can complement such strategies or provide alternative asset class fund managers with access to private without actually hiring private equity personnel.”
In the US it’s typical for a SPAC to invest 80% or a significant amount of its fund into one company, one defining acquisition. This is the case with International Metal (in fact, no money can be released from the fund unless the acquisition identified has a value of 80% or more of the initial amount of funds held in the trust), but not so with Energy XXI and IRF. Energy XXI has a minimum deal value of US$50m, and, along with IRF, shareholder approval is required for each acquisition, technically called business combinations, until the qualifying business combination is made, which is the point at which 50% of the initial amount held in the trust has been invested, so in the case of Energy XXI it is US$150m.
Investor change
By way of a quick history, between 1992 and 1996, there were 13 SPACs launched in the US, with only one not making a transaction and dissolving. These were aimed mainly at retail investors and so hovered around the US$30m size. With the tech boom they went out of fashion, but now they are making a comeback, in large part due to the efforts of Sunrise Securities, the US investment bank. In 2004 Sunrise modified the retail structure of SPACs to make it attractive to institutional investors. The first was International Shipping Enterprises (ISE), which raised about US$200m in December 2004. In August this year ISE bought Navios Maritime Holdings for around US$600m, and Navios’s unit closing price on September 23 was US$8.60, almost 45% more than the original offering price. The success of ISE kick-started the interest in SPACs: in 2004 SPACs raised US$500m. This year they are on course to raise US$5bn. Of the two that have listed on AIM, International Metals is raising US$201m and Energy XXI aims to raise US$300m. By the time all four have floated, a total of US$1bn should have been raised.
The shift from the US to AIM has been down to Sunrise again, this time in conjunction with UK stockbroker Collins Stewart. The US has become a less attractive environment for IPOs lately, and AIM’s flexibility and liquidity attracted Sunrise to the UK market. According to one source, recent changes to SEC procedures have made the SPAC structure virtually unworkable in the US. It takes 180 days or longer to gain approval from the SEC before an acquisition can take place. On AIM, the time from signing the merger agreement to obtaining shareholder approval should take no more than around 60 days. Also, the Sarbanes- Oxley legislation in the US imposes considerable additional cost, with little tangible benefit for development stage companies. On AIM there is no such legislative burden.
Threat
The emergence of SPAC does represent competition to private equity (as well as hedge funds.) Linney says: “They are not in competition in terms of the source of the investment funding, except perhaps from family offices and very high net worth investors. They are however in the market to secure deals that private equity funds may also pursue. SPACs can offer things that private equity funds can’t, i.e.ie an immediate listing and capitalisation. There is also an opportunity to partner with private equity funds on deals.”
In the US they’ve already attracted the industry’s attention. A number of them have private equity funds, like Paladin Capital and SV Life Sciences, as minority investors with a GP or VC on the board in an advisory role. The experience of the AIM SPAC boards in private equity is limited to International Metals, where CEO Alan Kestenbaum is also the chief executive officer of Marco International Corp, an international finance and trading company specialising in metals, minerals and raw materials, and did establish a private equity business for the company, which has seen him source and conclude a number of private equity deals.
The management team really is the crux of the matter when it comes to SPACs. Investors have to be able to trust that they can invest their money in good companies and make healthy returns. Energy XXI’s management team is headed by John Schiller, ex-vice- president for exploration and production at Ocean Energy, and includes Steven Weyel and David Griffin as chief operating officer and chief financial officer respectively. David Dunwoody and William Colvin are non-executive directors. IRF’s board is led by Angeliki Frangou, chairman and chief executive of Navios Maritime Holdings, a shipping company. The other board members include Andreas Vgenopoulos, chairman of Marfin Bank. The management team is led by CEO Georgios Kintis, of Greek firm MBG Venture Capital, and deputy CEO Nicos Koulis. Frangou is also the chairman and CEO of International Shipping Enterprises, one of the first SPACs aimed at institutional investors, which raised US$200m in December last year on its IPO.
One of the potential criticisms of SPACs is the amount of trust an investor has to have in the management team. As an adviser on one of the AIM SPACs says: “Management is key. There is some uncertainty over what they are buying (but this could also be said of a private equity fund), and the board may not have a track record in acquiring companies and making returns from them.”
It is also unclear as to why private equity and venture guys in the US are getting on board. Dan Primack, editor-at-large of Private Equity Week, said in one of his PE Week Wires that the reason “seems to be that many VC-supported SPACs are the next evolution of the venture partner movement, which already has spawned entrepreneurs-in-residence. Perhaps consider them management teams-in-residence.”
Perhaps understandably, SPACs have already attracted a considerable deal of criticism, with many dismissing their emergence this year as nothing more than a fad, with business development companies still fresh in the memory. In fact, the first ever SPAC to be launched in the US by a private equity firm is due to come to market very soon. MDC Acquisition Partners I is the first SPAC to be managed only by a private equity firm,; mid-market buyout house McCown De Leeuw & Co. McCown’s last fund performed poorly and the firm was reportedly told by placement agents that raising a new fund would be next to impossible. So it turned to the public markets and is set to launch MDC Acquisition Partners I, hoping to raise US$80m. It is thought that if MDC is successful with its SPAC, it could encourage other private equity firms to go down this route in order to raise funds, especially in the current climate where everyone with a blackberry seems to be raising a fund.
How popular SPACs become in Europe depends mainly on the two that have listed and the two that are about to, but also on the overall economic environment. “It’s a bear market phenomenon,” says Frank Moxon, head of corporate finance at William de Broe, the London stockbrokers. “It’s difficult to raise that sort of money in a bear market. When the music stops there’s going to have to be some clearing up to do.”
For Rapozo, the reason for their popularity is the return of the capital markets: “There is a large amount of money out there and these vehicles provide a disciplined way to do an acquisition, and they are attracting the attention of the private equity guys who want to do their own thing.” Rapozo thinks the future relationship between SPACs and private equity will be a mixture of informal partnerships and competition, or “co-operatition” as he calls it. “There will be some sort of competition between the two, but private equity and hedge funds will probably try to influence the market, like being an investor and on the board of SPACs.”
Piers Linney at Tower Gate Capital paints a similar picture: “It is possible for SPACs to work with private equity funds to find and secure transactions and provide immediate liquidity. SPACs provide an acquisition currency and a route to a listing and capital.”
It’s still early days in the UK for SPACs, and four floats in the space of a few months hardly heralds a new dawn, yet those advisers working on bringing the vehicle to AIM believe it won’t be just a fad, and with over US$5bn raised last year, the figures would seem to support this view. The private equity industry must now assess what, if any, sort of threat SPACs realistically pose. The lack of liquidity is one of the criticisms levelled, yet with SPACs, this flaw is removed. Ultimately it will come down to investor confidence, and while in the good times money may be forthcoming, in the next couple of years, when things are expected to slow down, investors may be reluctant to put their money into a management team who may well have no track record in private equity investing.
ventureeconomics.com |
