After years of investor indifference, SPACs have turned a corner, and now just about everyone wants in on the product that many believe is here for the long haul.
As of September 30, 185 special purpose acquisition companies are sitting on more than $58 billion of dry powder, according to SPAC Research. That’s a big spike from the $3.9 billion raised across 20 SPAC IPOs in 2015, as reported by the data service.
“When we first put ourselves on file in 2013, SPACs were not cool. SPACs were the skunk at the garden party,” says Dan Hennessy, chairman and CEO of Hennessy Capital, a SPAC sponsor whose fourth vehicle in August completed a merger with Canoo, an electric vehicle maker. “We were definitely wandering in the desert when we put our first SPAC on file.” It’s been a gradual process to convince private equity GPs to consider the SPAC as a legitimate exit for their prized portfolio companies. That’s a more recent phenomenon, Hennessy says: “PE firms have now woken up.”
So have other participants. This year has seen big-wig investors and other unusual names heading up SPACs, joining early entrants like Hennessy. The list includes billionaire hedge fund managers Bill Ackman and Jeff Smith; Gary Cohn, the former Goldman Sachs president and Trump administration advisor; baseball’s Billy Beane of Moneyball fame and former house speaker Paul Ryan.
“We’re [in] the second or third inning of a longer game where SPACs become a regular finance tool. Call it 20 or 30 percent of the IPO market and a regular part of PEs’ or VCs’ toolbox kit,” says Jeff Mortara, head of ECM origination at UBS, which in July worked as lead underwriter and stabilization agent for the largest SPAC IPO in history: the $4 billion IPO sponsored by Ackman’s Pershing Square.
The proliferation of SPACs isn’t dissimilar to the rise of other alphabet soup entities such as business development companies (BDCs), commercial mortgage REITs or agency mortgage REITs. Once unheard of, today some 20 percent to 30 percent of private equity firms incorporate BDCs into their capital markets strategy, Mortara estimates. “SPACs could be like that.”
Is investor psychology and the contagion effect at play here? Not so, says Mortara: “Don’t think of this as a fad or flash in the pan. Having diverse options is a good thing.”
Early entrants among the bulge brackets include TPG’s Pace Group, created in 2015 with the objective of sponsoring SPACs and other permanent capital solutions for companies. Apollo Global Management and Oaktree Capital also sponsored SPACs well before they got popular.
“The product is here to stay. I don’t know if it will be a $40 billion or $45 billion market every year, probably not, but the product works,” agrees David Batalion, which is not surprising since he formed the SPAC platform at Cantor Fitzgerald. “What you’re seeing is strong enough performance that makes the product very viable.”
The ‘greatest risk-reward of all time’?
A confluence of events are pushing the SPAC phenomena: strong equity markets; covid-19 shrinking if not eliminating, at least temporarily, the window for conventional IPOs; increasing familiarity, and finally, success begetting success – the allure caused by fear of missing out.
“Every person on the planet cares,” one leading SPAC underwriter tells us. “Every bank has a ‘SPAC guy’. Even every big PE firm. Every law firm is focused on it. You have grandmothers sitting in their house trading SPACs with their pandemic money.”
More recently, a number of successful transactions and retail attention involving companies that are already household names – DraftKings, Virgin Galactic – have lit a fire under the product, according to Jason Osborn of Winston & Strawn, who advised Diamond Eagle Acquisition Corp, the SPAC sponsored by former entertainment execs Harry Sloan, Jeff Sagansky and Eli Baker, which merged with DraftKings.
“Brand awareness has gotten people really excited,” Osborn says. “The SPAC asset class [now] has much greater gravitas than it had previously.”
Repeat or “serial” SPAC sponsors that have now had multiple successful blank-check vehicles have added fuel to the product’s adoption, he notes.
Adds the underwriter mentioned above who has revealed SPAC activity by grandmothers: “It’s the gift that keeps on giving. You do it, and it works out, and then you have credibility and more of a track record for the product.”
The initial ease of investment has been part of the allure for investors who want to be a part of the action. For $10 a “unit” – which includes one common share of stock and a fraction of a warrant – you enter the SPAC pool, which promises to invest in and merge with a company when it goes public. If the investors don’t like the company that is targeted, they can sell their units before the SPAC merger closes, and if a transaction ultimately never occurs, IPO investors get their money back. You’re really just buying a free option.
Once the company goes public, however, you are at the whim of the stock market. If your shares are in DraftKings, you’ve already started planning on where you want to buy your beach house. If your shares are in electric truck company Nikola, you may be a bit anxious right now.
Nikola quickly emerged as a darling among SPAC successes this year, but it hasn’t been all smooth sailing for the Tesla rival – which, generating zero revenue, has seen a number of skeptics questioning if the start-up will live up to its hype. Shares are worth less than half of their nearly $80 per share high in June, sinking dramatically in September after a report by Hindenburg Research alleged that the business is “an intricate fraud built on dozens of lies.” (Let it be noted that Hindenburg is a short-seller of Nikola shares.) Nikola denied the accusations, hired counsel and said it was going to refer the matter to the SEC.
More recently, awareness around the upside potential has dramatically increased. This has led to a change in the quality of businesses pursued by SPACs: it’s no longer the companies that can’t go public via an IPO choosing this option, but some of the best businesses. “We have these deals trading up [10 percent to 40 percent-plus] and all along investors are taking no risk. It’s the greatest risk-reward profile of all time,” the underwriter says.
Consider DraftKings, whose shares have soared some 488 percent as of September 30, since the SPAC with which it merged priced the shares at $10 a piece.
Structural elements have also evolved such that more investors recognize the SPAC has application for certain types of companies in certain situations. “You’ve started to see these lessons of what works reflected in the changes in the structure,” says Mortara. “Any underwriter can decide we’re going to put a new feature in this SPAC.”
For example, while sponsors are typically awarded with a 20 percent “founder promote” – paying a small consideration in exchange for a 20 percent capital base assuming completion of a successful SPAC merger – Ackman’s Pershing Square was the first to divert from that standard. Forgoing the 20 percent promote, Pershing took compensation in the form of a multi-year, long-term duration warrant that aligned Ackman more closely with other public investors.
That evolution took place in July and was largely replicated some 60 days later in Starboard’s $360 million SPAC IPO. “Jeff Smith saw the benefits of that structure,” Mortara says of the head of Starboard. “There are others who will further follow in their footsteps based on what we have in the pipeline.”
Not so easy
While the newly revived asset class continues gaining momentum, not all SPACs are created equal.
Raising capital for the SPAC is the easiest part of the process so long as you’ve got a good pedigree, according to Gores Group’s Mark Stone, senior managing director and head of the firm’s SPAC practice. “This is where I think we could come into trouble,” Stone says. “There are so many SPACs out there and people raising them – perhaps without the understanding that raising it is not the hard part; it’s the easiest part. The rest is much harder.”
Stone should know. The sponsor completed four SPAC mergers since 2016 – its latest, Gores Metropolis, merged with autonomous driving technology platform Luminar at a $3.4 billion value in August – and the sponsor has another two SPAC vehicles seeking targets.
The hardest part, Stone says, is what is called the “back end” of the SPAC process. That is, once the publicly traded SPAC has signed and announced the company with which it will merge, the SPAC sponsor must secure all the equity in the trust.
In other words, every investor in the SPAC IPO – 90 percent-plus of which are probably hedge funds, Stone says – has the option to redeem its warrant if they don’t like the company that is being targeted. By the time a deal closes, the SPAC sponsor needs to determine who the parties are that don’t like the transaction. The sponsor then needs to find new, interested parties and effectively rotate the shares to investors that want in.
“Everybody will say they can bring that, but that’s where I think there’s a big bifurcation in the SPAC. I don’t think a lot can,” says Stone.
Ideally, the makeup of the shareholder base at the back end is vastly different – comprising many long-term institutional investors, such as mutual funds and family offices, which aren’t going to invest before a company is identified, or during the SPAC IPO.
Still, a big part of the untold story, Mortara says, is that like the leveraged loan market, which is private, the long-term mutual funds favor the SPAC PIPE market over a traditional seven-day roadshow because it is controlled, its private and investors can spend more time getting to know companies: “The institutional players have very much shown up to support the PIPE market in the SPAC world.”
At the same time, a quality SPAC sponsor can bring immense value to a company looking to go public. “People tend to overlook what great sponsors bring to the table,” Osborn says. Today’s SPAC sponsors typically already have built great banking relationships, and their ability to bring in a network of potential PIPE investors speaks to that, he says.
Mortara agrees: “You have some very experienced business people who have done it before, and they can go to that much younger CEO who has ‘a tiger by the tail’ and say, ‘Let me tell you about the opportunities that are available and the mistakes that I made so you can avoid the pitfalls.’ The value to that is more than the promote they [the sponsor] charge.
“They know how the street works and can attract talent that wouldn’t come otherwise. All of those things add up to much higher profitability when you get to a ‘winner takes all’ strategy.”
Transformation of the IPO market
Private equity firms are known for their speed and agility. But taking a company public isn’t always so easy. “The [IPO] window is very finicky,” says Nick Petruska, executive vice-president and CFO of Hennessy. “The reason we’re seeing so many attractive companies going public via SPAC in an uncertain world, uncertain markets, uncertain macro landscape: This is a certain path to the public markets, which goes a long way.”
“There are a lot of people that believe the regular-way IPO path is broken,” adds Hennessy. “It’s so random in its application that very few companies pass the test to effect the regular-way IPO.”
At the same time, Hennessy says, private equity is slow. “You don’t know when you’re going to get your money back. It takes five years to invest, another five years for them to harvest. That’s a slow boat, and they pay a management fee on top of that for 10 years.”
A SPAC, on the other hand, embodies a time-certain and a valuation-certain outcome, Hennessy says. “It’s an IPO in a box, and it works. Within 90 days we’ll have you public. That’s a really powerful statement for a company that has a good, compelling public company road story.”
Hennessy’s third SPAC speaks to that, with HCAC III completing its merger with NRCG Group, a provider of waste management services, in October 2018.
“That was kind of the first period of heavy volatility that we saw in the last bull market – and during that time period, literally every capital markets transaction, not just IPOs, every follow on, every debt offering going on at the time – every single one of them was pulled due to market volatility. And NRC Group closed on time and on the terms we’d outlined.”
The SPAC process is not only faster, there’s less red tape – and that’s allowed new types of companies a path to access the public markets. “The M&A communication rules allow you more freedom to speak with investors, so it enables a different level of dialogue that happens throughout the entire de-spacing process,” Jocelyn Arel, partner of Goodwin Procter, says.
That’s in part driven by one important distinction between a traditional IPO and SPAC: An S-1 filing is highly regulated by the SEC, constricting the knowledge that is provided by the company to potential investors in a traditional IPO. Whereas an S-4 is filed in a SPAC because it’s a merger, lending to greater flexibility.
Unlike in a typical IPO, companies during the SPAC process can put out their projections such that investors can better calculate how the company is going to grow.
For public investors, that also creates an opportunity get on the ground floor of these high-growth tech companies at earlier stages of the equity value creation – rather than arrive at the very end, Petruska explains. “There’s been a lot of push-back from the investment community and even regulators that the first time these companies become available to the public markets, their growth is already behind them or their valuation is already massively inflated.”
Now, the market is seeing SPAC IPOs involving companies that even a year ago the public markets would have said: This company is just too premature to go public. “It used to be companies, that by the time they went public, their value would be a lot higher. The companies would be less growthy. The companies would be more mature. Most of the meat on the bone was taken by Sequoia or the venture or PE fund,” the underwriter says.
That wasn’t always the case. At one time a lot of growth happened after going public, Petruska says.
Now, adds Pete Witte, who leads EY’s research and analysis efforts in the PE space: “We are starting to see the opening of PE and private capital as an asset class. SPACs kind of play into that a little bit. They allow investors that might not otherwise have access to private market assets access to those opportunities, which is an important thing.”
Consider the public markets today versus 20 years ago, Witte says. Today there are half the number of public companies – and the public markets are dominated by larger companies. SPACs are another way to “give investors access to some of these opportunities where a lot of the growth is happening.”
It’s a positive thing, he adds. “For years, the trend has been toward more of our economy’s growth happening on the private side.”
For Gores Group’s Stone, the appetite isn’t boundless: “It’s a pendulum, so we might be heading too far in one direction,” he says.
“I think we might end up back in the middle. I don’t think this can continue as it is for eternity. I don’t know that the public markets are smart enough to pick which electric truck companies are going to make it and which aren’t.”
Still, the amount of dry powder sitting in SPACs is dwarfed by private equity’s $3.5 trillion of ready capital. In fact, there’s a shortage of SPACs in biotech and technology, media and telecom, Mortara says, adding that most TMT-focused SPACs are either under letter of intent or in an M&A dialogue. Further, despite the perception, there are only four SPACs greater than $1 billion out there right now.
“SPACs are a drop in the bucket,” Mortara says. “The reality is you put a SPAC IPO up, it increases the count of available SPACs, but they drop off the back of the bus when they do a business combination.”
Playing the long game
More than ever, GPs are exploring ways to hold certain assets beyond the traditional PE structure to avoid getting out while there is still growth to capture. To achieve more upside, PE firms are increasingly using secondaries and rolling minority stakes as a new majority shareholder is brought in, while long-hold funds have also become more common.
The SPAC can be another solution for private equity firms that aren’t ready to call it quits on their prized assets.
Unlike an outright sale in many cases, the SPAC outcome and desired valuation isn’t debt dependent. That can be particularly valuable at times in which credit is unavailable – as was the case this summer when covid fears led debt markets to largely shut down.
For example, if the public comp set for a particular private equity holding is valued 4x or 5x EBITDA higher on average, explains Hennessy, “then maybe, we, through our SPAC vehicle – we can help that private equity owner close that valuation gap by taking the company public and without the use of an inordinate amount and dangerous amount of leverage.”
Hennessy’s first and third SPAC deals are great examples. Believers in the public company story, Cerberus Capital Management and JF Lehman & Co each retained 50 percent stakes in Blue Bird and NRCG, respectively, upon their mergers with HCAC I and HCAC III.
Cerberus, for its part, had already owned Blue Bird for around a decade, and still wanted in.
“That was kind of a culminating point in the evolution of the SPAC asset class,” Petruska says. “That was really the first time you saw a blue-chip private equity firm portfolio company do a SPAC.”
In a time of rapid change and bewildering evolution in so many areas, Zoom and SPACs – innovative tech and finance vehicles – are the darlings of 2020. Zoom brings crisp efficiency to the process of raising a SPAC or PIPE – which often require 100-plus meetings (as in the case of the Ackman SPAC), Mortara says. “I don’t think it’s going back. Who needs that last Thursday night trip to see the LA and San Francisco investors when you can use video efficiently to build relationships and close deals?”