Special Purpose Acquisition Companies (Spacs), which use the IPO market to raise funds for acquisitions, have proven their ability to weather the current market turbulence.
As of May 21, 26 such IPOs had come to market in the US this year – indicating that 2020’s Spac IPO volume could well match, if not beat, that of 2019.
It is a good result for Spacs, which, in a previous incarnation, had fared poorly during the 2008 financial crisis.
“So far, everything we’ve hoped for has proved out, in that they have been very resilient in the market dislocation,” says Alysa Craig, managing director at Stifel in the M&A group and head of the firm’s Spac practice. “In [early May] in particular there has been a lot of activity.”
In part, she says, that is because of the hybrid nature of Spacs: “While the IPO market has taken a pause, the M&A market has not really stopped during this crisis. There were Spac deals announced and closed during the worst of the market correction.”
Among deals completed during the coronavirus crisis was a $3.6 billion three-way merger between Diamond Eagle – the Spac of Harry Sloan, former chief executive and chair of MGM – and sports betting company Draftkings, which, combined, acquired the smaller SBTech.
Stifel advised SBTech in the deal, which closed at the end of April.
We are going to see a lot more activity as the year goes on. I’ve certainly never received this many calls about Spacs as a liquidity alternative
– Alysa Craig, Stifel
Craig says “there were virtually no redemptions” – the majority of the investors in the original Spac from Sloane decided to stay invested after the merger. The deal was de-risked through a private investment through public equity (Pipe) deal.
“It was a $414 million PIPE, and another $405 million stayed outside the PIPE; it traded up to as high as $19 from $10 per share prior to close, despite the headwinds from Covid-19,” says Craig. Investors were keen on the growth story in the merger. Craig says the fact that the Spac structure allows for publishing of forward projections through the merger proxy meant that investors were focused on 2021 numbers, rather than those of a choppy 2020.
Craig says that is a testament to the evolution of Spacs, which are now in their third generation.
She says: “We are going to see a lot more activity as the year goes on. I’ve certainly never received this many calls about Spacs as a liquidity alternative.”
Better alignment
Several structural changes were made to Spacs after the last financial crisis. The first is that there is now downside protection for investors – 100% of the money from the Spac IPO now sits in a trust and earns interest prior to business combination. That has meant that while markets have fallen, Spacs have provided a yield play for some investors and have seen their prices outperform.
In former iterations, Spac founders could use the proceeds for expenses, run the trust down and then fail to find a deal, leaving investors out of pocket.
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Alysa Craig, |
“A typical founder today has to invest 2.5% to 3.5% of their own money into the deal and would lose all if there is no business combination,” says Craig. “All interests are much better aligned now.”
The second change has been to decouple the shareholder vote from redemption rights. Now, if an investor needs to redeem upon combination, they can still vote for or against the merger.
That means if investors are squeezed for liquidity and simply have to cash out, they can still vote in favour of the deal and ensure the merger goes ahead for the others.
And finally, the warrant structure has been altered to be less dilutive.
More comfort
The result has been greater confidence in Spacs which has also attracted larger companies – in turn giving investors and targets more comfort.
“Seeing larger IPOs and subsequent combinations, as well as their success has helped with investor appetite,” says Doug Adams, global co-head of equity capital markets for Citi.
In February, Citi lead Churchill Capital III’s IPO raising $1.1 billion – the largest raise for a US Spac IPO to date.
In May last year, Churchill Capital I acquired Clarivate Analytics – an information service provider to the life sciences industry – for $4.2 billion.
Among other large, high-profile and successful Spac mergers is Virgin Galactic. It was bought last year by the Spac Social Capital Hedosophia, which raised over $650 million in an IPO in 2017.
The success rate for current Spacs is “remarkable,” reckons Craig. “The success rate of third-generation Spacs post 2010 is 90% – 95% for those with cash in trust of over $100 million – as defined by ability to source and close a business combination.”
Spacs are offering a different track to the traditional options of selling up, taking a firm public, or a direct listing.
Craig adds that they have become competitive with private equity.
“If you are a company, a private equity firm will give you 8x value in cash, but you can get 10x in a Spac transaction because public markets offer a better valuation outcome. Then it is a tempting offer because you get the cash consideration with a good partner, but also the equity as an upside.” She says she has seen some companies thinking about full exits converting to Spacs.
Another development has been the creation of Spacs to target a particular theme or industry – typically energy, media or tech.
Others are broadening out to include environmental, social and governance opportunities. Citi was sole lead in May on a Spac focused on sustainability.
The Spac, Sustainable Opportunities Acquisition Corp, raised $300 million at IPO. It will be looking to make an acquisition in the next 18 months of a firm that aligns with ESG criteria.
Scott Leonard, chief executive at the Spac, says: “We need companies to become as efficient in their use of resources as possible. Climate change is the biggest problem facing our planet. There are a lot of good companies out there from an ESG perspective, but we think we can work with one to make them great.”
He adds that the transparency of Spacs suits companies with a strong ESG profile well.
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