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Investment Dealers Digest: 29 January, 2007
Market Awaits SPAC Flood as Deal Deadlines Approach:
After a rush of blank-check IPOs in 2005 and 2006, some of these vehicles are approaching the cutoff date to find a deal with the threat of liquidation looming
By Ken MacFadyen
There are essentially three phases to the lifecycle of blank-check or special purpose acquisition companies (SPACs): the IPO, the 18-month window within which the shell companies need to find an acquisition, and the actual deals. A good chunk of the blank-check vehicles launched in the 2005/2006 rush to market now find themselves nearing the third and final leg, which means they either have to find a deal or liquidate. Most would prefer the former option.
"I'm pretty sure these people don't want to give the money back," says Jeff Rosenkranz, head of middle-market M&A at Piper Jaffray. "There'll be a lot of folks looking at their deadlines who will be furiously trying to put money to work."
For those not familiar with the product, a SPAC is essentially a shell company that is floated publicly with designs on merging with a private business to take it public. The shells, once floated, typically have an 18-month window within which to find a deal (although the period can vary). If a deal doesn't happen, the SPAC gets shuttered and investors get their money back.
The urgency described by Rosenkranz is already apparent. Of the 30 SPACs that announced acquisitions in 2006, 24 were inked in the last six months of the year, while nine of the 12 SPACs that completed business combinations also did so in the second half.
The SPAC's climb to respectability has come in surges. The business model has been around for years, but it wasn't until the fall of 2005 that it started reappearing on people's radar. Well-known names, such as Jonathan Ledecky, Steve Wozniak and Richard Clarke, were among the early converts. Then came the bulge brackets. At first, it was solely the specialist boutique firms that underwrote the IPOs, followed eventually by the likes of Citigroup and Deutsche Bank.
Now, the next step is actually to find the deals, and the deadline is looming for the blank-check companies that went public in either late 2005 or early 2006. As the pressure mounts, flags are being raised over just how desperate some entities might be to put money to work.
According to the internal database of investment bank ThinkEquity Partners, 15 SPACs or blank-check companies currently need to wrap up a deal within the next nine months. One of those, Richard Goldstein's media-focused Courtside Acquisition Corp., has even gone past its deadline, but it did manage to negotiate an extension.
Among those on the clock are Grubb & Ellis Realty Advisors, the Michael Kojaian-led entity formed last January to hunt down deals in the commercial real estate market, and Richard Clarke's Good Harbor Partners Acquisition Corp., established by the former White House counter-terrorism chief to pursue a business combination in the security sector.
While the urgency might imply that some corners will be cut, other forces at work could maintain the integrity of the SPAC -sponsored reverse mergers. Namely, the investors who back these vehicles, primarily hedge funds and other institutional investors, can block a proposed merger if as few as 20% of the shareholders voice dissent.
Four deals have already been blocked. TAC Acquisition Corp., Millstream II Acquisition, China Mineral Acquisition and Coastal Bancshares Acquisition have all had proposed mergers quashed and have either folded their operations or are in the process of liquidation.
Nathan Thompson, an analyst at ThinkEquity, views the blocked deals as a demonstration of discipline. "It proves that the product does work, and it's not simply a back door into the public market," he says.
Meanwhile, George Bickerstaff, a managing director at boutique investment bank CRT Capital Group, calls the thwarted transactions "the ultimate punishment."
He points out that the target company loses because it wastes three to six months on a deal process and emerges with nothing to show for it. The SPAC's backers lose because, even though they can recoup their investments, they've still had their money tied up for more than a year. And the SPAC management loses because they're liable for the costs. When TAC Acquisition's deal was overturned, management was on the hook for $1.16 million.
"All these companies have different structures, but usually management will put up their own money, typically around 2% to 3% [of the total capitalization], but sometimes more," Bickerstaff notes. "These investments are usually in the form of warrants, which go to zero if management can't get a transaction approved."
Thanks to this rigorous approval process, Bickerstaff expects most SPACs to exercise "extraordinary discipline" even in the face of looming deadlines.
The deal flow
Up to now, the stout deal flow has surprised some onlookers. The first high-profile transaction to come via the wave of 2005-vintage SPACs was the acquisition announced last March of smoothie vendor Jamba Juice by Steven Berrard's Services Acquisition Corp. International. Following deals include Highbury Financial's merger with the former mutual fund business of ABN Amro; the $465 million acquisition of Smart Balance Food Products by Boulder Specialty Brands; Acquicor Technology's $260 million purchase of Jazz Semiconductor, and, most recently, Endeavor Acquisition's announced merger with clothing retailer American Apparel for $244 million.
While deals will surely continue to materialize, the environment for SPACs may gradually become more difficult. The reverse-merger blueprint has until now been used to sidestep difficult IPO conditions for companies that still want to go public.
However, the IPO market began to show improvement last year and exhibited momentum in the fourth quarter that many anticipate will carry over to this year.
"SPACs tend to be inversely correlated to the IPO market," Bickerstaff says, noting that anecdotally, the strength he has seen in the IPO market seems to correspond with an accompanying falloff in SPAC IPO filings.
Meanwhile, more M&A competition is coming from the private equity market, which, along with a gradual buildup in corporate acquisitions, continues to push valuations higher. "To win a deal, the SPAC has to be completely compelling [to the sellers], especially at the large end," Bickerstaff says.
But considering the scrutiny that deals face from shareholders, SPACs can't always make valuations the compelling part of their story. "The economics always need to make sense. You really need to find a very good private discount compared with the public marketplace," Bickerstaff adds. "If comparable companies are valued at 10 times earning in the public markets, then you need to find a target valued at six times earnings."
In spite of this catch-22, Bickerstaff fully expects the majority of SPACs still seeking targets eventually to find and close deals. He estimates that the number of liquidations will probably stay consistent with what the market is currently seeing, with around 10% folding.
Meanwhile, even as deal activity from the SPACs augments an already robust M&A environment, Piper Jaffray's Rosenkranz notes that relative to the rest of the market, SPAC deals still represent only a niche area of the M&A universe.
"I think we'll clearly see more of these SPAC deals, because there are more of these companies out there, and they're forced to put money to work," he says. "But as you look at the market as a whole, these kinds of deals still represent a very small percentage of the deals getting done."
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