SPAC investors are asked to buy in -- on faith
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Once the domain of penny-stock peddlers, blank-check companies have come a long way.
Such financing vehicles sell stock to the public to raise money before they actually own or conduct any business. Then they use the money to buy companies. Historically, they were underwritten by small investment firms and marketed to individual, or "retail," investors.
Now, seasoned corporate deal makers with operational expertise are backing these so-called blind pools in their most recent incarnation: specified purpose acquisition companies, or SPACs.
Investors who buy in are betting that the deal makers will pull off lucrative mergers or other deals, yielding a profit for everyone. But it is all on faith.
The deal makers selling the shares are quietly drumming up the type of interest from financiers, hedge funds and Wall Street investment banks usually seen in bigger and more-mainstream banking deals. December's initial public offering of shares in Freedom Acquisition Corp. raised $520 million and was underwritten by Citigroup Inc., demonstrating the newfound respect these deals are receiving on Wall Street.
The current frenzy of mergers and acquisitions and cash-flush investment firms seeking places to put their money have created fertile ground for SPACs. They provide a faster path for private companies to go public and for private-equity funds to exit their investments.
A SPAC "gives you access to every aspect of the capital markets and more flexibility," says Nicolas Berggruen, head of an eponymous family-owned investment vehicle with assets of more than $1 billion. He also is co-manager of the Freedom SPAC.
Since 2003, 74 SPACs have raised $5.61 billion in IPOs and 56 are awaiting regulatory approval to go public, according to Reverse Merger Report, an industry trade journal. In 2006, 11 offerings raised more than $100 million, compared with nine deals in 2005 and only one in 2004. The American Stock Exchange lists 23 SPACs and has 25 more in its listing pipeline, lending the structure, which previously could be listed only over-the-counter, the credibility of being on a regulated exchange.
Here is how SPACs work: One or more "sponsors" register a company with the Securities and Exchange Commission and raise money through an IPO. The sponsors, who also serve as the officers of the SPAC, then have 18 to 24 months to buy a business.
Once a target approves an acquisition, management must win the backing of at least 80 percent of a SPAC's shareholders. If it fails, the SPAC liquidates and pays the IPO proceeds back to investors, minus banking and other fees. Some underwriters are deferring a small portion of their fees until the SPAC buys a business. If a deal fails, the deferred portion of the fees, which vary, can be returned to investors.
The "blind pool" monikers come from the uncertainty over what the future business will be. In the 1980s and 1990s, some of these entities were at the center of fraud schemes, prompting the SEC to impose shareholder protections that most modern SPACs have adopted and investors have demanded.
Of course, not all SPACs succeed. Last summer, Merrill Lynch & Co. failed to complete a $125 million SPAC offering because it couldn't raise enough money. In December, Banc of America Securities downsized a planned IPO to $100 million from $150 million. And four SPACs are currently liquidating, having failed to make an acquisition before their deadline.
While the deals still are relatively small, some Wall Street bankers are finding attractive underwriting opportunities.
"We're seeing higher-quality management teams with proven track records that are extremely interested in this vehicle," said Ciaran O'Kelly, head of U.S. equities at Banc of America Securities. "SPACs are very much on the radar of most bulge-bracket investment banks today."
Sophisticated investors have been willing to bet on Freedom, the biggest SPAC to date. They include hedge funds Och-Ziff Capital Management LP, Jana Partners LLC and mutual-fund giant Fidelity Investments. Och-Ziff and Jana declined to comment. Fidelity didn't return calls for comment.
Hedge funds like SPACs because they can take advantage of their unique securities structure. Each SPAC is listed through both shares and warrants-certificates giving the right to buy a security -- which typically trade at different prices until an acquisition is announced. Hedge funds can use arbitrage strategies to profit from the price differences. SPACs give investment firms the opportunity to participate in a private-equity style of investment in a publicly traded security.
Targets of SPACs and their investors say they use a "bet on the jockey" strategy when deciding to sell out to SPACs or buy into them, putting more pressure on SPACs to have pedigreed management. Management typically agrees to buy a significant stake in the SPAC during the IPO, often around 20 percent, and promises to hold the shares for as long as three years.
"The key is the quality of the money," says Robert Frucht, a partner at law firm Buchanan Ingersoll & Rooney PC, which represents American Apparel, a clothing retailer that recently agreed to be bought by a SPAC.
One of the sponsors of Freedom is Martin Franklin, chief executive of Jarden Corp., a $2.5 billion company listed on the New York Stock Exchange that makes household products under brands including Mr. Coffee and Sunbeam. Freedom has an independent committee to ensure that Freedom's operations won't conflict with Jarden's interests.
Mr. Franklin says he was inspired to start a SPAC after his friend Michael Gross, a founding executive at private-equity firm Apollo Management LP, last year raised $300 million for Marathon Acquisition Corp., a SPAC. Mr. Gross, who is now at hedge-fund manager Magnetar Capital LLC, which manages $4 billion, declined to comment.
"The old SPACs just didn't interest me. You need to have size," Mr. Franklin says. Freedom aims to buy a business with a market value of about $1.5 billion, financing part of the deal with loans or another share issue.
Some sponsors are putting their own money behind these deals: Messrs. Franklin and Berggruen put $25 million each into Freedom; Mr. Gross invested $5.5 million into Marathon Acquisition.
Companies recently acquired by SPACs also cut a higher profile. Endeavor Acquisition Corp., a SPAC that raised $130 million in 2005, announced in December that it plans to buy American Apparel for about $244 million. The SPAC's shareholders will vote on the deal this summer.
In November, fruit-juice seller Jamba Juice Inc. went public on the Amex after it was purchased by Services Acquisition Corp., another SPAC, for $265 million. Financier George Soros's hedge fund bought stock in the SPAC after the acquisition plan was announced and now holds more than 5 percent of Jamba Juice.
Freedom's Mr. Franklin says he believes larger SPAC deals -- even a $1 billion SPAC -- will eventually happen but predicts that would require "some tinkering," such as extended acquisition deadlines. As for his own SPAC finding something to buy, "I don't feel rushed at all," he says.
First Published February 1, 2007 12:00 am