No End In Sight for SPAC Backlog

NEW YORK (Reuters) – A year ago, “blank-check” companies were all the rage, fueling the U.S. market in initial public offerings.

Now they are struggling badly as investors have grown much more risk averse, financing has become tougher to get and costlier, and the economic downturn has made many potential buyout targets less appealing.

There is now a backlog of blank-check entities set up when markets were healthier that are unable to put their funds to work effectively, making IPOs of new ones even less appealing.

Formally known as special purpose acquisition companies (SPACs), these shell organizations raise money in an IPO with the aim of acquiring an unspecified business in the future.

“There's an oversupply of SPACs,” said Jorge Freeland, a Miami-based corporate lawyer with law firm White & Case LLC. “People don't want to invest in SPACs if they are not confident a deal can be done.”

Businesses acquired by SPACs become publicly traded after shareholders approve the deal. Typically a SPAC has two years to buy a company, or else investors get the IPO money back.

Last year, a record 65 of them went public, raising $11.6 billion, according to Thomson Reuters data. But so far in 2008, only 14 have issued stocks and warrants, raising $3.6 billion.

While the overall IPO market is at a near standstill, what worries investors in SPACs is there are now so many. According to Morgan Joseph, a mid-market investment bank, there are 64 SPACs that raised $12.2 billion still seeking acquisitions.

“They're just sitting there in a logjam,” said Francis Gaskins, an analyst with IPO Desktop. “There's stale merchandise in the pipeline.”

The volatile equities markets are also making investors scrutinize acquisition targets more closely.

For all the hype surrounding SPACs last year, only a handful have delivered on their promises, with investors balking if they think a deal's valuation is too high.

One exception has been Heckmann Corp (HEK.N: Quote, Profile, Research, Stock Buzz), which has seen its shares rise 31 percent since May, when it announced it had acquired a Chinese bottled water company.

In contrast, Marathon Acquisition Corp (MAQ.A: Quote, Profile, Research, Stock Buzz), which raised $320 million in a 2006 IPO, recently had to restructure its purchase of container ship company Global Ship Lease Inc.

And a plan by Hicks Acquisition Co (TOH.A: Quote, Profile, Research, Stock Buzz) to buy plastic container firm Graham Packaging Holdings, in a $3.2 billion deal announced in June with Blackstone Group LP (BX.N: Quote, Profile, Research, Stock Buzz), got a tepid reaction from investors, with its shares barely moving.

CREDIT CRUNCH

The going has gotten tougher for SPACs as the credit crunch has chased away hedge funds, traditionally the sector's major investors. Many hedge funds are unable or unwilling to raise as much debt for investments as they could in 2006-2007.

“SPACs are directly impacted by the amount of leverage available to hedge funds,” said Tina Pappas, managing director at Morgan Joseph. “If they could get the 4-to-1 or 5-to-1 leverage they used to get, SPACs would be more interesting even if the capital markets aren't doing well.”

The jumpy markets are also curbing the appetite for SPACs.

“Right now when you can trade bank stocks like speculative stocks, it makes everything else much more difficult,” said Neil Danics of SPAC Analytics, a research service.

WHEN WILL THEY COME BACK?

Pappas doesn't see the SPAC market picking up until at least early 2009, and said she believes investors will be much more discriminating. The days of the mega-deals seen last year are over, with smaller deals becoming the norm, she said.

“The winning ingredient will be to focus on smaller deals,” Danics agreed. “They can always raise more capital, and it's harder to deal with too large a capital structure.” He sees more room for smaller SPACs in the sub-$50 million range.

And the SPACs' focus is likely to change.

“Rather than being industry specific, they'll be team specific,” Danics said. “You'll see SPACs focused on emerging markets, or larger SPACs run by a team that has shown it can buy the entire company if it needs to.”

But their return to investors' graces will hinge on their ability to make acquisitions. “People thought the acquisitions would go faster,” said White and Case's Freeland. “I don't think SPACs will regain their former luster.”

By Phil Wahba

(Editing by Braden Reddall)