Leveraged buyout firms are finding it nearly impossible to exit portfolio companies. There has been a grand total of four IPOs by LBO-backed companies in the US so far this year. The M&A route is proving equally challenging, with one industry trade group reporting first-half volumes down some 30%.
Another option could be opening up, however, in the form of special purpose acquisition companies (SPACs). These vehicles have so far endured criticism for structural inadequacies and a low number of completed acquisitions.
But one such vehicle, Hicks Acquisition Company, moved last week to acquire an LBO-backed firm, although its path is still fraught with difficulties.
The SPAC, headed by private-equity veteran Tom Hicks, is looking to buy Graham Packaging, a consumer products company owned by Blackstone Group.
Billed as the largest-ever acquisition of an industrial company by a SPAC, the proposed acquisition was viewed with scepticism by stakeholders of both companies. Hicks’ shareholders suggested that the US$3.485bn price tag was too steep, while Graham Packaging debtholders were up in arms over the lack of protection afforded them.
While there is plenty of time to negotiate, it is clear that Hicks, Graham Packaging and their advisers have a lot of work to sell investors on the merits of the acquisition.
An agreement in principle was announced before the market open last Monday, but a definitive agreement was not signed until later that morning, resulting in a delay in the submission of roadshow documents containing specifics on the transaction.
“The conference call was a disaster,” said one SPAC investor of the hastily arranged discussion of the acquisition on Monday morning, without roadshow materials. “I like the Hicks management team but this deal is a little underwhelming. In a market that has just entered bear territory, investors have tons of alternatives.”
Trading in Hicks Acquisition warrants reflected that sentiment and also the confusion over deal specifics. The warrants, which are exercisable at US$7.50, traded as high as US$0.99 ahead of the call before plunging to close at US$0.52, down US$0.17, while the shares were unchanged at US$9.29.
The warrants are considered the best proxy for how likely shareholders are to approve the acquisition – if an acquisition does not close within two years of Hicks’ September 2007 IPO, the proceeds held in trust (currently US$9.80 per share) are returned to shareholders and the warrants expire worthless.
If successful, the acquisition would leave most of the Graham Packaging capital structure in place. Hicks plans to assume US$2.3bn of the existing debt, after repaying some US$156m of that debt. Blackstone would receive US$350m in cash, 35m shares, and 2.8m of the 7m founder warrants that Hicks purchased on the IPO, giving it a 34% stake and making the buyout firm the largest shareholder.
“The debt on these businesses is an asset because you cannot replace it in the current credit environment,” pointed out one SPAC banker. “We would not be surprised to see buyout firms look to complete a similar reverse-merger into a SPAC where the seller keeps a large enough stake that it is possible to sell without triggering a change of control.”
That may be true, but Hicks’ shareholders appear unlikely to approve the transaction as currently structured. The principal concerns are valuation and a net debt multiple of 5.2x 2008 Ebitda versus 2.6x for comps.
Hicks has committed to vote 13.5m shares, a 20% stake acquired for US$25,000 ahead of the IPO, in favour of the acquisition. But approval from at least 50% of shareholders is needed for the deal to go through, with no more than 30% of shareholders voting against.
In the interim, Citi, which led Hicks’ IPO and advised it on the acquisition, will be marketing the purchase to investors. As is the case with any SPAC acquisition, the challenge is to attract interest from long-only industry specialists to transition the shareholder base from what is predominately hedge funds.