Special Purpose Acquisition Companies (SPACs): What Are They?
This article is sponsored by Securities Commission Malaysia, under its InvestSmart initiative.
Before investing in a company, there are many things to consider such as the company’s profit track record, its business model, annual earnings, growth projections and its P/E ratio. However, for Special Purpose Acquisition Companies (SPACs), none of this information would be available during its initial public offering (IPO).
Without all the necessary information to make an investment decision, what can potential investors rely on? Read on to find out.
What are SPACs?
A SPAC is a corporation which has no operations or income generating business at the point of IPO and has yet to complete a qualifying acquisition (QA) with the proceeds of such offering. In simpler terms, a SPAC is basically a publicly-traded buyout company that raises money to pursue a merger or acquisition of an existing company. SPACs raise monies through an initial public offering (IPO) for an unspecified acquisition in a targeted industry. A substantial portion of the monies raised would be placed in a trust and if an acquisition is not made within a specified period, the monies held in trust would be returned to investors.
SPACs have no operations or income generating business at the point of its IPO, but will utilise proceeds from the IPO to undertake mergers or acquisitions. It is effectively a group of experienced industry specialists coming together to raise money through investors for a business venture, and the success of the SPAC is entirely dependent on the quality of its management team.
A SPAC operates like a reverse IPO. As it has no assets prior to its IPO, its listing is also sometimes referred to as a ‘blank cheque IPO’. Investors in a SPAC typically buy a unit and receive a warrant, which trades separately and can only be exercised when the company completes a takeover. Once the qualified acquisition has taken place, the shares will continue trading as a regular listing on the stock exchange.
The structure of SPACs is similar in most countries, with about 90% of the IPO funds held in a trust until a takeover target is found. Because the IPO proceeds are invested in Government bonds or money market funds until the SPAC makes an acquisition, in theory the returns should mirror those of a fixed-income fund, but that is not necessarily always the case.
Suitability of SPAC for investing
A SPAC must place at least 90% of the gross proceeds raised in its IPO in a trust account immediately upon receipt of all proceeds. The monies in the trust account may only be released by the custodian upon termination of the trust account. The trust account may only be terminated if the QA is completed within the permitted time frame, or upon liquidation of the SPAC.
From the SC’s perspective, the suitability for listing of a SPAC is assessed on a case by case basis, and may take into account any factor it considers relevant. The SC may refuse to approve an application notwithstanding the requirements contained in the Equity Guidelines if the SC has reason to believe that the approval of the application would be detrimental to the interest of investors or contrary to public interest. In assessing the suitability for listing of a SPAC, the SC will take into consideration, among others:
- Experience and track record of the management team;
- Nature and extent of the management team’s compensation;
- Extent of the management team’s ownership in the SPAC;
- Amount of time permitted for completion of the qualifying acquisition prior to the mandatory dissolution of the SPAC;
- Percentage of amount held in the trust account that must be represented by the fair market value of the qualifying acquisition; and
- Percentage of proceeds from the initial public offering that is placed in the trust account.
Under the SC’s Equity Market Guidelines, SPACs are given 36 months from the date of the IPO listing to make a QA by utilising up to 90% of its funds or a minimum of RM150 million.
Additionally, the resolution on the QA must be approved by a majority in number of the holders of voting securities representing at least 75% of the total value of securities held by all holders of voting securities present and voting either in person or by proxy at a general meeting duly called for that purpose.
Why should investors consider investing in a SPAC?
With the stringent regulations put in place by the SC in its approval process, the emphasis is on ensuring that the management team’s experience and track record commensurate with the SPAC’s business objective and strategy, whilst the management team’s compensation and reward structure commensurate with the potential returns to public shareholders. Ensuring the needs, interests and concerns of investors are met will also ensure that the potential of SPACs can be fully realised.
Aside from its investment value, SPACs have an important role in encouraging and stimulating the growth of their respective industries. This is because their key management consists of experts in the field. Thus, they are able to exploit the opportunities available and create values based on their strong foundations in trade and market knowledge.
SPACs also offer an opportunity to invest in a potentially high growth company with a risk exposure of about 5% to 10% (not guaranteed), while the returns can be as high as 3 to 4 times (not guaranteed) depending on the value created upon the SPAC’s QA.
Additionally, the funds raised from the IPO are “protected” as they are placed in a trust fund which will be returned to investors if and when the SPAC cannot meet the deadline set. All investments to be made by a SPAC will be scrutinised by independent third party experts, the regulator and even shareholders themselves.
SPACs represent a promising new investment platform for investors with a stronger risk appetite and looking to get into an investment at the earliest possible opportunity.
What should investors pay closer attention to when investing in a SPAC?
1. Low-Cost Entry
Imagine being offered the opportunity to buy into Facebook when Mark Zuckerberg was still in his Harvard dormitory (or Bill Gates or the late Steve Jobs, for that matter). Unlike traditional IPOs which bring established capitalised assets, employee productivity and revenue streams to the market, SPACs offer investors a unique opportunity to buy into a company at the beginning of its business development and growth cycle. Due to the fact that they have nothing (hold no assets) at the time of listing, SPACs present a unique opportunity for retail investors to participate in the start-up of established and operational private companies that are usually only accessible by private equity or hedge funds.
2. The Management Team
The founding stockholders or promoters, who usually hold up to a 20% stake in SPACs, are the brains behind the operation of a SPAC. They would bring with them a distinct blend of first-hand industry knowledge and experience, asset transaction and risk management expertise and experience, their own entrepreneurial spirit, and profit motivation and a desire to create value for their shareholders.
3. Risks & Returns
SPACs may be asset-less at the time of listing, but they do have a business plan that is as detailed and robust as that of any IPO. No two SPAC business plans, models and strategies would be alike. However, due to market pressure to execute a QA quickly after listing, SPACs can fail at the point of making their QA because the due diligence process was rushed, or they bought a QA that was in a sector that was outside of the management’s expertise. As a shareholder, one would need to understand the SPAC strategy and realise that selecting the right asset that fits the SPAC strategy may take additional time to ensure that quality assets are delivered and shareholder value is not compromised.
So, can SPACs offer investors a higher payout upon completing a successful QA and forging a sustainable business model? The quick answer is “Yes, it may be possible”. However, understanding and judging the management team’s experience, track record and ability to execute its acquisition and growth strategy is the most important key to enjoying great returns from SPAC investing.
Since investors receive warrants which are immediately tradeable (but only exercisable after a QA is complete), some investors prefer to take a position on a SPAC’s warrants. Whilst warrants are cheaper than shares, the risk is that the warrants would expire worthless if no acquisitions are made.
Also, because the IPO proceeds placed in trust are invested in Government bonds or money market funds, returns would typically mirror that of a fixed-income fund until the SPAC concludes its QA. Only then will the shareholders get to enjoy dividend pay outs similar to other share investments. Investors must be willing to put their money away and be patient until the SPAC either completes its QA or liquidates itself (which could take up to three years).
There are rewards and risks associated in any capital markets trade. Ultimately, it is the responsibility of the SPAC Management Team and the regulators to present all the factors clearly so that investors can make their own informed decision.
We have all heard it: Nothing ventured, nothing gained. What do you stand to gain if you undertake the risk of investing your money?
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