One of the poorer acronyms in the corporate finance world is SPACs, or Special Purpose Acquisition Corporations, as they are properly called. SPACs have been around since the early ’90s, but only in their most recent form in Canada since 2008. Unfortunately, these investing vehicles have had mixed success until recently. Their inconsistent success rate has caused many to doubt their long-term viability, but more recent successes must certainly cause the Bay Street community to take notice and there are several reasons one might see SPACs eventually rivaling more traditional private equity financing models as the structure of choice for institutional and high-net-worth investors alike.
SPACs are publicly traded holding corporations with no operating business that raise money in an initial public offering with the intent of investing in undetermined operational assets in the future. SPACs are marketed on the strength and experience of their management team, board of directors and advisers, highlighting their experience in building companies, mergers and acquisitions and private equity investing. In addition to using strong management to court investors, SPACs are offered as units consisting of shares and discounted warrants with a limited lock-up period, providing potential for near immediate returns. SPACs carry several attractive protections for investors:
• The requirement for at least 90% of gross IPO proceeds to be held in trust until a qualifying acquisition is approved.
• Liquidity protection: in the event that a qualifying transaction is not completed within three years, funds are reimbursed plus accrued interest.
• Further liquidity availability as the shareholder has the right to convert shares to pro-rata escrowed funds if it decides to dissent against the qualifying transaction (rather than simply block the transaction as was previously the case in the U.S. before they revised the rules).
The TSX requires SPACs to raise a minimum of $30 million pursuant to its IPO. However, the average size of the six Canadian SPAC IPOs completed to date is $196 million, with the smallest being $70 million. In all, about $1.2 billion has been raised.
Thus far, only three of the six existing SPACs have completed qualifying transactions. Those deals, all of which closed since that start of 2017, have a total value of $764 million:
• In March, Kew Media Group Inc. (TSX:KEW) completed the acquisition of six small, dispersed media companies, rolling them up into a global media player.
• Alignvest Acquisition Corp. became Trilogy International Partners Inc. (TSX:TRL) via a reverse takeover of its acquisition target in February.
• Acasta Enterprises Inc. (TSX:AEF) closed a set of three acquisitions in January 2017 and converted its former Class A shares to newly issued Class B shares (for more details, see table).
When compared to traditional private equity, the acquisition rate of SPACs has been quite lacklustre. One explanation is the fact that once a deal is announced by the SPAC, the investors have the option to sweep back their capital if they do not like the investment, and such issue does not exist in traditional private equity where the capital is committed regardless of the investments made. Further, the length of time it takes to get a SPAC deal done and the level of disclosure can be prohibitive for many sellers and their shareholders who may instead opt for a traditional strategic or private equity buyer.
In the United States, listed SPACs had been largely viewed as retail investment vehicles offering private equity-like asset exposure with the benefit of liquidity and risk protections due to their structure. This combination remains largely unavailable to the average retail investor outside of SPACs, nor to the high-net-worth individual having access to private equity or hedge funds, which both typically have minimum lock-up periods and no guaranteed return. Since 2003, the use of SPACs as a viable alternative for investors looking to participate in corporate acquisition opportunities has risen sharply within the American market—between 2003 and 2008, more than US$21 billion in gross proceeds were raised through 161 SPAC offerings. Over a similar timeframe, the average SPAC IPO size grew nearly four-fold, to US$226 million in 2008 from US$40 million in 2004. This increase in ticket size, alongside the liquidity protection and guaranteed returns, attracted hedge funds as the primary SPAC investor class, with more interest in the potential arbitrage strategies surrounding the warrants/shares versus the future acquisitions.
This growing U.S. market interest eventually led the TSX to adopt SPAC rules in 2008—at the same time global equity markets were entering the Great Recession, which caused the U.S. SPAC sector essentially to shut down, as SPACs were one of the fastest and easiest sources of cash for hedge funds to cover shareholder redemptions. Three years later, the SEC approved a rule change proposed by both the NASDAQ and the NYSE, which led to the resurgence of SPACs popularity among potential sponsors and management teams (see table). That change allowed shareholders to waive their right to vote on an acquisition and instead tender their shares for pro rata escrowed cash. This approval included the removal of the requirement to have a super-majority vote in order to complete a business combination.
This feature has been included in Canadian SPACs as well. When combined with SPACs’ other attributes—outstanding advisory boards (who are typically also investing their personal capital) and deep investment teams—it is easy to see this sector growing in popularity here despite its relatively modest start to date. For a shareholder, it’s as close as one gets to a free option as you can find on Bay Street, which makes it much easier to live with the funny name.