31 March 2021

A SPACtacular opportunity for Australian PE sponsors?

What do the following U.S. celebrities and sports identities all have in common in the world of finance: Jay-Z, Shaquille O’Neal, Ciara Wilson, Serena Williams, Alex Rodriguez, Steph Curry and NFL quarterback Colin Kaepernick?  Can’t guess?  Well, they are all “strategic advisers” or “promoters” of one or more SPACs.

SPACs have seemingly defied gravity in the U.S. markets in the last year.  Many of the largest global PE firms have sponsored SPACs including Apollo, KKR and TPG.  Not a week goes by that a U.S. SPAC has not approached one of our sponsor, start up and even strategic clients.  And there has been a significant recent uptick in Australian media pieces on SPACs and whether they should be able to list here.

SPACs are blank cheque companies which list on a stock exchange and then typically have two years to find an operating business to acquire (subject to extension by securityholder approval).  They are typically formed by a private equity-backed sponsor or other famed entrepreneur who trades on their experience and reputation to attract investors and find a suitable target for acquisition.  Once the target is identified (i.e. “deSPAC”), its owners usually take some money off the table but also roll equity into the SPAC.  At this point, SPAC securityholders have a right to vote on the proposed acquisition and redeem their stake if they disapprove.  At that point, it is usual to raise new money too.

On the whole, SPACs have been phenomenally successful in the U.S. in post-COVID times, with approximately US$83 billion being reportedly raised through SPAC IPOs alone in 2020 and US$97 billion so far this year. 

Deal execution speed has also been there.  SPAC founders typically have 2 years to find a deal, but many SPACs are going public much faster than that.  One of the largest SPAC mergers to date, the US$7.3bn deal between Blackstone-backed U.S. benefits provider Alight and Foley Trasimene Acquisition occurred less than 6 months after Foley Trasimene went public, and there are a number of examples of even shorter merger periods.

SPACs are permitted in the London market but are rare because of the regulatory constraints - reform of this impediment is imminent.  Earlier this year, the Singapore Stock Exchange (SGX) also said it would begin formal consultation on listing SPACs.  If SGX allows SPAC listings (anecdotally we hear there are a few in the pipeline), Singapore would be the first major stock exchange in Asia to do so, giving it a point of differentiation from its rivals, the Hong Kong Stock Exchange and ASX.  See more on the U.K. and South-East Asian experience in our accompanying articles.

Why are SPACs attractive to PE sponsors?

Key factors driving the U.S. SPAC success include a SPAC focus on growth sectors, the redemption right for securityholders (making the investment a free swing), streamlined IPO disclosure requirements and that the ability for target investors to retain a stake in the merged entity while gaining liquidity. 

For private equity and other financial sponsors there are other immediate and obvious advantages both of raising a SPAC and exiting a portfolio investment by merging with a SPAC, 

The founding financial sponsor’s warrants are usually exercisable within 30 days after the deal, with the warrant shares accounting for 20% of the SPAC’s equity and typically costing less than the post-offering market price of a SPAC share.  This means that there is a defined carry at the outset (replacing the more customary GP carry).  The potential rewards reflect the sponsor’s risk - up front costs can be significant and are entirely at the sponsors’ risk, but assuming that a deal can be achieved, a financial sponsor can achieve a significant stake at a lower cost of capital. 

Fundraising can be streamlined, with the ability to draw from public sources meaning a wider sphere of potential investors and potentially side-stepping some of the time commitments and procedures of raising funds from LPs.  It is common for the sponsor of a SPAC to secure an anchor commitment through a PIPE deal with an outside investor – which also offers the potential for additional equity after the SPAC goes public.

Lastly, whilst there is also the potential for significant liquid returns over a short timeline, SPACs can also permit financial sponsors to hold investments for longer than permitted in traditional closed-end funds.

For financial sponsors looking to sell a portfolio company by making it public, merging with a SPAC can be a faster process compared to a traditional IPO.  Because the SPAC has already gone through an IPO prior to seeking a merger counterparty, SPAC mergers help reduce the timing, regulatory and other hurdles to achieving a public listing.  A quicker listing process and less regulatory blackholes, which have the ability to throw out timetables, also reduce the risk of an IPO not proceeding due to volatile conditions in post-COVID markets.

Downsides to SPACs?

SPACs have historically hit more than a few bumps in the road.  Critics of SPACs argue that the success of SPACs is temporary and cyclical, pointing to the steep fall in SPAC listings following the Global Financial Crisis and arguing that SPACs will fail to perform for investors by overpaying for, or failing to secure, deals and simply being too expensive.  Regulators have also been increasing their focus on SPACs, with the SEC warning earlier this month that it was looking into the structural and disclosure issues with SPACs.  Acting SEC Chair Allison Herren Lee stated the obvious when she said earlier this month ‘never invest in a SPAC based solely on a celebrity's involvement or based solely on other information you receive through social media’.

Others see them as much more than a fad.  Scott Kleinman, co-president of Apollo Global Management, has recently been quoted as saying ‘If you think about it from an investor’s perspective, the SPAC is an incredibly efficient way for an institutional investor to access the private markets, from a traditional acquisition standpoint…It’s a very low cost way for that institution to be able to play the acquisition market…As long as you believe we’re going to be in a low-interest environment for the foreseeable future, which we…happen to believe, then I think you’re going to see this stay for some time.’

The obvious downsides for securityholders are investing in an unknown entity with no clear business or assets, no returns initially and possible dilution at the time of deSPAC.  But there are inbuilt protections for investors – the money sits in trust, the securityholders vote on the acquisition once identified and there is the usual regulatory oversight for a listed vehicle. 

Will we see SPACs in the Australian market?

ASX continues to take a very cautious approach to SPACs.  ASX cites the problematic history of cash box companies in Australia, as well as key differences between the size and regulation of Australian and U.S. markets.  In the 1980s, cash boxes were inexplicably valued at more than the cash they actually held.  Similarly, many recent U.S. SPACs have traded at a premium to redemption value pre-acquisition identification.  Following the 1987 share market crash, Australian cash boxes were also acquired below cash on hand (ironically, and critical to the regulatory response, SPACs do not seem to suffer NTA discounts). 

This cash box history is why ASX now requires that, at listing, non-investment entities have either less than half of their total tangible assets (including IPO proceeds) in cash, or commitments to spend at least half their cash within a certain time period.  Entities must also meet the requirements of either the profit or assets test to list.  Remember too that ASX cannot change its rules without approval of ASIC, and ASIC will look at SPACs very carefully - the time taken to get ASIC comfortable may bypass the SPAC popularity phase.

Even though we understand the need for caution, we do believe that appropriate safeguards could be put in place to manage the investor risks associated with SPACs. This could include limiting who can be SPAC sponsors (Australian financial services licensees for example), heightened good fame and character checks for SPAC directors, CEOs and CFOs, adequate prospectus disclosure with clear warning statements and post-acquisition escrow for the sponsor and management.

The real issue for us is whether to give retail investors in Australia an opportunity to buy into the type of alternative investments only available to private capital.  The dynamic of capital raisings in the U.S. has meant that retail investors have not had the opportunity to participate at IPO, so they end up buying in at a level that is higher than the redemption amount.  This may be less of an issue in Australia where retail participation at IPO is more common.

There is also concern in the market that Australian regulatory caution to embrace the SPAC phenomenon will drive Australian companies (particularly in the technology sector or where favoured by ESG investors) to look to be acquired by SPACs on foreign stock exchanges.  This may take money and intellectual property offshore and make it harder for local investors to participate in the growth.

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