SPAC Overview

SPAC News

Dealmaker: February/March, 2008
By: Scott Eden

Brainstorm : Year of the SPAC

A few months after Martin Franklin took hedge-fund giant GLG public through a back door, the trickle of blank-check companies has become a torrent.

It was the SPAC to start all SPACs. Less than a year after going public in December 2006, raising $528 million for its blind pool, a little-known special--purpose acquisition company called Freedom-Acquisition Holdings consummated a deal, fulfilling its mission. Through felicitous connections, Freedom's sponsors — two old friends and business associates named Martin Franklin and Nicolas Berggruen — had lined up GLG Partners, a major London-based hedge fund, as their target a few months after their company's initial offering. Early investors in Freedom's units doubled their money, and the sponsors, who received GLG equity cheap due to the nature of the SPAC's structure, made a fortune.

Thus came the gold rush. It didn't take long for some of Wall Street's savviest dealmakers to catch on — and pile in, making 2007 the Year of the SPAC, with 66 blank-check IPOs, mostly on the American Stock Exchange, raising just over $12 billion, some 250 percent over the previous year, according to Dealogic. And from what Dealmaker sees, not even the early market hiccups will slow down the torrent in 2008, with eight SPAC IPOs of $500 million in the pipeline as of the end of January. (The average SPAC ballooned to $182 million in 2007, from $85 million in 2006.)

"You're just starting to see the first wave of [SPAC] acquisitions, and it started with Freedom's acquisition of GLG," says Bruce Mendelsohn, a partner at the law firm Akin Gump, who has worked on a number of SPAC issuances. For the uninitiated, a SPAC is basically private equity investing through a public-company structure — an IPO with a buyout shop's mission. The sequence proceeds roughly like this: raise cash through an offering, usually courtesy of a big bank underwriter as well as hedge funds and others looking to put their money to work creatively (most of these offerings occur via the American Stock Exchange); stick the money in a trust; search for and acquire a solid target without having to leverage the thing to the hilt. Get the deal approved by the SPAC's funders, effectively completing the reverse merger (most move the listing to the New York Stock Exchange at this point). Then take a bow, as you've presumably created instant value for your shareholders — and secured a 20 percent promote, generally in the form of warrants, for yourself.

Hedge funds like the deal because they get to play in the private-equity space with little downside. (If they don't like the deal, they vote no and get their money back.) The sponsors like it because they carry a 20 percent or so stake going into the acquisition, for relatively little money down. It's basically a way for those with a proven track record to monetize themselves (in exchange for their skill in picking a target), which explains the star-studded list of SPAC promoters over the past year. Thomas O. Hicks (see "Home Team Advantage," page 82) raised $552 million for his Hicks Acquisition Company I last September. Nelson Peltz raised $920 million this January for Trian Acquisition I. Ron Perelman, meanwhile, is seeking to raise some $500 million for his SPAC, MAFS Acquisition Corp. There was even the first $1 billion SPAC: Liberty Acquisition Holdings, which went public last December.

So pervasive is the trend that even people outside traditional dealmaking circles have jumped in to literally cash in on their names. Apple co-founder Steve Wozniak helped raise $140 million; former Vice President Dan Quayle cooked up $433 million; investors even ponied up $200 million to back pro-sports dealmaker Tony Tavares and one of his all-star board directors, baseball legend Hank Aaron. The underwriters are blue-chip firms like Citigroup, Deutsche Bank and Bank of America, among others, with several other Wall Street firms, including Greenhill, Lazard and Keefe, Bruyette & Woods actually issuing them.

But until Freedom came along, SPACs still carried a stigma: Some still associated them with the blind-pool schemes of two decades back, when boiler rooms floated penny-stock shells in order to dupe old ladies in Peoria. Perhaps more importantly, they were limited by their size — often only $50 million in capital or less — leaving little buying power for financiers looking to do headline-grabbing takeovers and even less incentive for big-league under-writers to get onboard. But 2007 was the year the game changed.

The most recent iteration of modern-day SPACS began about four years ago, after a group of small investment-banking firms — including Morgan Joseph, Early Bird Capital, BroadBand Capital and Ladenburg Thalmann — started underwriting SPACs as a way to satiate hedge funds' growing appetite for new places to put their money. Typically, these early SPACs were designed to raise $50 million in capital. Most were floated on the over-the-counter bulletin board, and used in large part by hedge funds for the arbitrage opportunities presented by the SPACs' warrants structures, rather than as long-term investments. The ideal blind-pool sponsor? A well--connected, well-heeled entrepreneur with access to serious deal flow.

Enter Martin Franklin. With his impressive pedigree and broad experience buying and selling companies, the 43-year-old deal junkie was repeatedly approached a few years back by these small underwriters trying to convince him to sponsor a SPAC. Since 2001, when he accumulated a large stake in Jarden Corp., he has been its chairman and chief executive, building the consumer-products concern into a $4.6 billion NYSE-listed dynamo by busily snatching up companies, including American Household, Diamond Brands (which had entered into bankruptcy proceedings) and the U.S. Playing Card Co., maker of Bee and Bicycle card decks.

Franklin had been similarly acquisitive when, at 27 years old, he started Benson Eyecare Corp. in 1992, building it through acquisitions into a national distributor and retailer of eyeglasses with annual revenue of $350 million. (When he and his partners sold it in 1996, Franklin personally banked something north of $30 million.) "Instead of breaking up companies, I wanted to start one," says Franklin, explaining why he left his previous job to start Benson. Previously, he had worked alongside his father, Roland Franklin, who at one time ran the operations and oversaw the divestiture of businesses for famed British corporate raider Sir James Goldsmith.

At least initially, however, Franklin rebuffed all the pitches. "Quite frankly, I never saw the merit in SPACs," he says. For one thing, the typical SPAC investor base seemed too heavily weighted with speculators and arbitrageurs. For another, the vehicles weren't raising enough money to go after what Franklin deemed worthy targets. They were so small that "even once they made acquisitions, most of them didn't have a following on Wall Street, and they were illiquid," says David Spivak, managing director in equity capital markets at Citigroup, one of the leading SPAC underwriters and one of the vehicle's great cheerleaders. "They’d announce an acquisition, but there would be no one to bid up the shares and no one who really wanted to step in and own them." But in the spring of 2006, Franklin changed his tune after his friend Michael Gross, a founding partner of Apollo Management, invited him to join the board of Marathon Acquisition Corp., his newly minted $300 million SPAC — at the time the biggest ever taken public. Franklin agreed to serve on Marathon's board and, after seeing the size and scope of the vehicle up close, he was sold. "I began to understand that not only were these vehicles gaining legitimacy," he says, "but they were a more efficient way of going public for certain kinds of companies."

In December 2006, Freedom Acquisition Corp. went public on the AMEX — the go-to market for larger, second-generation SPACs — raising nearly $530 million and eclipsing Marathon as the biggest SPAC of all time. As the two sponsors of Freedom, Franklin and Berggruen promised to put up $25 million each as a co-investment once a target was found. They also put up another $6 million apiece in at-risk warrants. Typical of SPACs, the warrants are designed as an incentive for the vehicle’s sponsors to find a good transaction. (A SPAC’s management team receives no compensation during the search process.) If no target is found — the conventional deadline is 24 months — then the warrants become worthless, the SPAC -liquidates and all investors get their money back (sometimes with a small amount of interest).

Critics have pointed out that such "supercharged" incentives, combined with the relatively tight deadlines, might force sponsors to pursue dubious deals in the interest of merely getting one done and avoiding the loss of their cash tied up in warrants. But Franklin and others counter that safeguards are in place: Once a target is found, the transaction is subject to a shareholder vote, with 80 percent approval typically required for consummation. Additionally, if an individual investor doesn't like the deal on the table, he can elect to have his money returned. Or, of course, he can simply cash out of his position. For SPAC investors, then, the main investment risk is opportunity cost. "It's attractive for the investor as long as you have faith that the vehicle will find a good transaction," says Franklin, who notes that SPAC investors are "betting on the jockey."

But this, in turn, may cause other problems, notably the potential for conflicts of interest. Some of today's issuers may have fiduciary obligations elsewhere — to the buyout firm he's a partner of, say, or, like Franklin, to the public corporation he leads. For that reason, byzantine SEC disclosures are sometimes necessary to determine what kinds of companies a SPAC can target and what kinds it can't.

Because of his post at Jarden, for example, Franklin's SPAC didn't have dibs on consumer-goods businesses. Those opportunities had to go to Jarden first. Such restrictions have the potential to put specific SPACs in a tight spot. If a partner at a particularly ­omnivorous private-equity shop decides he wants to sponsor a SPAC, the field of targets for that SPAC can be substantially narrowed, reducing the odds that the vehicle will eventually find a high-quality business to buy.

Despite some of these limitations, when the time came to nego­tiate a deal, Franklin found that he had something to sell potential acquisition targets as well — an attractive alternative. For companies on Franklin's radar, the two main routes were a sale to a buyout firm or a public offering. For its part, a SPAC compares favorably to private equity because it needn't take on nearly as much debt.

As for going public, a SPAC can promise a more predictable cash infusion than a traditional public offering can. "In an IPO, you don't know exactly how much money you're dealing with until you've actually gone on the road and tried to do it," Franklin says. "The ability to allocate the capital in the entity exactly how you want to is much easier with a SPAC." Berggruen, for his part, also saw the advantages of a SPAC vis-à-vis rival bidders in the wider deal market: "Everybody’s on the same level playing field, and the only way to win something is by paying a higher price and using a lot of leverage, which I don't really love as a way to acquire a business. So the idea of having a cash vehicle seemed compelling." Fast-forward a year, after the subprime chaos and the resulting credit crunch, "and it's even more compelling today," Berggruen says. "Cash is at a premium."

Hicks, the leveraged-buyout pioneer, agrees: "Particularly with the current credit issues, the LBO industry is on hold until the banks sort out their bridge loans. So I think we have a very unique environment to look at transactions right now." Hicks intends to do a deal worth between $1 billion and $2 billion.

Freedom eventually "de-spac’d" when it acquired $23 billion hedge fund GLG Partners. Valued at $3.4 billion, the reverse merger closed in November 2007, 10 months after Freedom completed its fundraising. It paid GLG's owners (including Lehman Brothers, which has a 20 percent stake) with 230 million newly issued Freedom common shares and $1 billion in cash ($530 million from its IPO, the balance in debt). GLG's original holders retained nearly 75 percent ownership in the public entity. The stakes of Freedom's sponsors in GLG are now worth $120 million to $140 million apiece.

Berggruen was the prime mover behind the deal. Because he was friendly with Noam Gottesman, one of GLG’s founders, he knew that the hedge-fund manager "wanted to do something with his business, potentially, so I called him." The deal gave GLG an efficient way to obtain capital for expansion into U.S. markets while avoiding the costs and distractions of a straightforward public offering. (Days after Freedom announced the deal, GLG paid $3.2 million in penalties for what the SEC deemed was unlawful short-­selling, and the hedge fund has been sanctioned in the U.K. and France.) GLG's shares have since moved from AMEX to the NYSE and were trading recently at about $12 per share. And if you had bought Freedom at its issuance, you'd have doubled your money, making Freedom-GLG among the best-performing SPACs ever. That success has enabled Franklin and Berggruen to raise $1 billion with their second blank-check effort, Liberty Acquisition Holdings. The two intend to target a deal worth up to $5 billion. This time, they've got $6 million each tied up in at-risk warrants and will put up $30 million apiece as a co-investment once they announce a deal. They've also cut the number of warrants in half, which should further grease the dealmaking skids, Franklin says.

The most advantageous change from the norm for the Liberty SPAC, though, is its prolonged deadline: The sponsors will have three years to complete a deal, instead of the standard two. The reason is simple: Franklin and Berggruen have built up goodwill.

Despite the excellent returns shown by Franklin and Berggruen in their initial SPAC deal, it remains to be seen whether the vehicle will stand the test of time. After all, relatively few SPACs have actually de-SPAC'd so far. Of the 76 SPACs listed on the AMEX since the beginning of the boom in 2005, only nine have successfully found targets. So far, only a few, such as Cold Spring Capital, have had to liquidate after missing their deadline, but there are rumors swirling around several others (including Michael Gross's Marathon) that may be in jeopardy. "I think we need to see the returns generated by these SPACs," concedes Citigroup's Spivak. "We clearly are seeing some higher-profile individuals and teams sponsor them, but we need to see the returns generated for shareholders." Almost inevitably, with so many sponsors on the prowl for deals, SPACs will start competing with other SPACs for takeover targets. That's why Franklin and Berggruen have sought to distinguish Liberty from the crowd. "We've tried to keep ourselves unique both in scale and structure," Franklin says, "so that we don't find ourselves competing with another SPAC for a situation."