Europe eyes SPACs as survival aid for credit crisis
The US has shown the way with special purpose vehicles that could prove a safe bet in today’s volatile market.
Financial markets have rarely been as challenging as they are today. Conditions are volatile, confidence is evaporating and there are few signs of an upturn any time soon.
Such an environment tends to inspire caution. Investors, particularly long-only institutions, sit on their heels and wait for the climate to improve.
They tend not to rush into new ideas or test out the latest scheme dreamed up by creative investment bankers. And, in this particular cycle, they are particularly reluctant to put their money into special purpose vehicles.
Even so, some European capital markets protagonists are hoping to convince investors that there is one exception to the rule: Special Purpose Acquisition Companies, or SPACs.
These first came to light in the US back in 2003 and they have become a formidable part of the US merger and acquisition market.
The equity vehicle
Under the SPAC structure, one or more well-known entrepreneurs put their names at the head of an equity vehicle, which then attempts to raise money in the equity markets. Once the money is raised, the management team has up to two years to find an interesting acquisition target to reverse into their publicly listed vehicle. During that time, the cash sits in trust earning interest for investors.
The equity is distributed via units, valued at $10 or €10 apiece and, after 30 days, the units evolve into, typically, one share and one warrant. If the management team finds a suitable acquisition, investors vote on it and 70% need to vote in favour for the deal to go through.
The management team is expected to put its own money into the SPAC. They are not paid while they search for an acquisition but they do receive about 20% of the initial sum raised once they have found a deal and it has been approved.
Deals tend to be considerably larger than the SPAC itself so the private company receives shares as well as cash. In fact, one of the largest SPACs to date involved the hedge fund GLG. The SPAC raised $500m but it bought GLG for $3.5bn, taking out a $500m loan and issuing $2.5m in new shares to acquire the business.
A golden year
SPACs have attracted considerable support. In the past five years, about 160 of these vehicles have completed initial public offerings (IPOs), raising more than $18bn. Last year was a golden year – 68 SPACs were launched, raising $12bn and accounting for 27% of the US IPO market. Even in the depressed climate of this year, more than $4bn has been raised.
Supporters believe SPACs are the perfect defensive instrument, designed to thrive in bear markets. “Private equity activity is down, debt is hard to get, valuations are low and the IPO market is very quiet. If a company is looking for an exit, a SPAC offers them the perfect opportunity,” says Quentin Nason, managing director at Deutsche. “Lots of investors are sitting on 30% cash. And SPACs are the perfect bear market vehicle,” he adds.
In effect, investors who buy into SPACs are saying that they believe the management team is sufficiently well- connected and well-respected to uncover acquisition opportunities that ordinary mortals (or investment bankers) cannot. In return, they are prepared to lock up their money for up to two years, albeit earning interest, and hand 20% of the initial shares to that management team.
Generous returns
Sometimes the structure works like a dream. Dick Heckmann, a veteran of the US water industry, was behind the $433m Heckmann Corporation SPAC, which bought China’s fifth largest bottling company, China Water & Drinks, for $625m. Heckmann Corporation listed in November 2007 and then the Chinese deal was announced six months later. Heckmann shares rose by 70% upon the news, providing investors with a more than generous return.
At other times, SPACs are less rewarding. In May, Goldman Sachs was forced to pull its first and only attempt at the structure, Liberty Lane Acquisition Corp. Goldman cited market conditions. Competitors pointed out that the bank had changed the structure, offering investors one share and half a warrant and offering the sponsors (or the management) a different type of remuneration.
Overall, however, the evidence suggests that the US market is over-crowded to the point of saturation. Of the 169 SPACs launched since 2003, 40% are still looking for acquisitions.
“The US market has more than its fair share of SPACs. A couple of years ago, the structure was really appealing,” says one SPAC expert. “Now US investors are a lot more choosy. They want top-quality management teams and they want all their money in trust,” he adds.
Perceived risks
Historically, a percentage of the IPO money raised was absorbed by the sponsors and their bankers. Now, investors regard this as unacceptable. “They need to see the sponsors are putting their own money at risk,” says another SPAC banker.
If the US market is flooded out, European bankers are hoping to garner interest in the sector from investors and entrepreneurs on the other side of the Atlantic.
At the end of June, Deutsche launched a €275m ($438.42m) SPAC, sponsored by three leading European business figures and focusing on the Mittelstand market in Germany, Austria and Switzerland. The three sponsors were Roland Berger, chairman of the eponymous management consultancy; Thomas Middelhoff, chairman of retail group Arcandor and former CEO of Bertelsmann; and Florian Lahnstein, who headed up European investment banking at Bear Stearns and German investment banking at UBS.
European acquisitions
Deutsche’s Mr Nason says: “We are focusing very much on doing a SPAC which is based in Europe, run by Europeans and looking for a European acquisition. The Mittelstand is the backbone of Germany. There are 1300 companies in the sector and we are only looking for one.”
The European market is different from the US in two important respects. First, US SPACs are not allowed to look for potential acquisition targets before they list, whereas European SPACs can. Second, there is a three- to six-month hiatus between a US SPAC finding an acquisition and shareholders voting on it, because all such deals have to be filed with the Securities and Exchange Commission. In Europe, the gap between finding a deal and voting on it can be as little as a few weeks.
“There is less bureaucracy in Europe. We are hoping that the next few SPACs attract more interest from European investors,” says Petra Zijp, partner at Dutch law firm NautaDutilh.
The European market is not entirely untested. Nine SPACs have joined the Alternative Investment Market in London, and two have been listed on Euronext: Pan European Hotel, a €115m company looking for deals in the hotel sector, and Liberty International, a €600m vehicle looking for any good European deal that it can find.
“There is a lot of potential in this market. I am working on these vehicles full time. The challenge is to get European institutional investors interested in SPACs,” says Ms Zijp.
Some market watchers believe the structure has to improve to tempt Europeans in and reignite interest among US investors. “The SPAC model is appealing but we do not believe the sponsors should be getting 20% of the initial equity just for finding the acquisition,” says James Corsellis, partner at niche investment bank Marwyn Capital. “After all, 25% of successful deal-making is getting the right investment but 75% is making the company work. It would be fairer if more of the management team’s remuneration was tied to the performance of the business.”
Deal-by-deal approach
This has not been tried before but an element of performance-related remuneration may be introduced in time. Even the most experienced SPAC bankers admit that, in Europe in particular, the structure is evolving on a deal-by-deal basis.
Citi, one of the leaders in the field, has issued nothing in this sector since March, although one of its US SPACs, Hicks Acquisition Company, found a $3.2bn acquisition last month. Citi was also behind Liberty International, launched in February when equity markets were falling fast.
Most bankers concur that the logic behind SPACs is sound. Private companies gain an alternative route to market; sponsors gain the chance to make a lot of money by doing what they are good at and investors ‘piggy-back’ off their expertise.
Setting a precedent
In today’s market, however, nothing is simple and nothing is easy. In recent months, enthusiasts have spent considerable time explaining SPACs to the European investment community. But many institutions are choosing to sit on their hands and wait for conditions to improve.
There is, however, evidence to suggest that SPACs work. Some 14% of them have found that deals though shareholders have not yet voted on them, but 36% have been approved and 40% have seen the share price rise. That leaves 10% which have gone into liquidation and returned the money to shareholders. “These deals tended to be smaller and very US-centric,” says Mr Nason. “Now managers are more global and SPACs are larger.”
For the time being, the jury is out on European SPACs – and it may remain that way for several months to come.
