What’s Special About Today’s Special Purpose Acquisition Companies

The article covers the recent trend of companies using a special purpose acquisition company as a vehicle for becoming publicly traded.

This year, Virgin Galactic set its sights on being the first publicly listed human spaceflight company by the end of 2019. It will do so through a deal, announced July 9, where Social Capital Hedosophia (SCH), a special purpose acquisition company (SPAC), will get a 49 percent stake in a newly merged entity, while Virgin Galactic will become publicly listed on the New York Stock Exchange, where SCH shares currently reside. The deal also marks another milestone as one of the highest profile mergers through special purpose acquisition companies.

“It offers certain advantages over doing a conventional IPO in the sense that it essentially has already raised the money itself, and so the time commitment for the management is somewhat reduced,” George Whitesides, chief executive of Virgin Galactic, told SpaceNews. Shareholders can have liquidity and the company can take advantage of public markets.”

Increased Use of SPACs

Virgin Galactic is one of a string of companies in recent years that have aimed to go public through a SPAC—colloquially known as blank check buy-out funds or blank check shell companies. In April, Chuck E. Cheese owner Queso Holdings Inc., controlling stockholder Apollo Global Management LLC, and blank check fund Leo Holdings Corp. was hoping to enter into a similar scheme. They intended to take the family fun center public, but walked back from it in July with no explanation.

All in, 28 special purpose acquisition companies have raised a collective $6.8 billion in the US during the first half of 2019. It’s the largest six-month total since 2007, according to the Financial Times.

“There is more broad-based acceptance of SPACS now,” Clayton Hale, co-head of equity capital markets for the Americas at Citigroup, told FT. “You have well established financiers launching them and seasoned public company executives helping to run the businesses they acquire.”

So what’s triggering the rise?

Making Space for Special Purpose Acquisition Companies

SPACs are a relatively straightforward entity. A SPAC is a shell company formed by a veteran dealmaker or high profile venture capitalist in order to acquire or merge with another company. They typically price shares around $10 and then spend up to two years looking for a target to purchase. The dealmaker is often vague about what they’re after.

For example, SCH’s founder and CEO Chamath Palihapitiya (an early employee at Facebook and all-around tech superstar) was suitably ambiguous about what he had in mind: “We intend to focus our search for a target business operating in the technology industries.”

But it was enough. SCH priced 60 million shares at $10 in September 2017. And it looks like it’s going to pay off.

The benefit of a SPAC is that it streamlines the time to IPO, does away with lock-ups, and gives investors and employees liquidity quicker than a traditional IPO would afford. On the company’s side, it shaves off some of the typical financial filings you’d see surrounding an IPO like income statements and balance sheets. It may not be the most transparent way to go public, but with less red tape, it’s no surprise the concept is seeing a resurged interest since spiking in popularity in 2007.

“Every major law firm, every major investment bank, every private equity firm knows about the SPAC program now,” Douglas Ellenoff, a partner at Ellenoff Grossman & Schole LLP and an advisor to numerous SPACs, told Bloomberg. “They’ve drawn massive attention in the marketplace.”

SPACs Then and Now

The template for SPACs was laid out in the 1990s, but it was the lead up to the financial crisis of 2007-2008 that saw one of the highest spikes in their usage as an investment vehicle. In 2008, SPACs accounted for 28.5 percent of all IPOs, according to Bloomberg data. But deals were smaller then. And the sponsors were coming from the fringe rather than the big names we’ve seen as of late.

“There just wasn’t a long track record of closing deals,” Joel Rubinstein, chair of Winston & Strawn LLP’s capital markets practice told Bloomberg. “There wasn’t enough experience then.”

As the economy collapsed, so too did the number of SPACs. Few had the nerves to test the markets.

But a more fertile M&A market, combined with record levels of dry powder has revived the model. The Sir Richard Bransons of the world will likely raise their profile even higher. The average deal size of SPACs has shot up to $220 million this year, compared to $126 million in 2014. And it’s likely to climb over the next year or two.

Former CEO of Honeywell David Cote is currently on the hunt with Goldman Sachs’ GS Acquisition Holdings, a SPAC which raised over $600 million last year. And former Citigroup investment banker Michael Klein is already onto his second SPAC, Churchill Capital Corp II, a $690 million shell company, the largest of 2019 so far.

“We’re at an inflection point where the rise in SPACs is leading to more attention,” Andrew Pendergast, vice president in the private equity and mergers and acquisitions practice of insurance broker Marsh LLC, told Bloomberg Law.

Special Purpose Acquisition Companies: Either the Next Big Thing or a Passing Fad

Momentum is certainly on the side of SPACs, though they’re a vehicle that relies heavily on leadership, an ability to find a smart acquisition, with a timer running in the background. Provided the IPO markets see more Virgin Galactic type deals and less Chuck E. Cheese drop-offs, interest is likely to continue in SPACs. But they’re far from a sure thing.

According to an analysis of SPACs from 2010 to 2017, the vehicle underperformed by about three percent yearly in the three years preceding their IPO.

“I’ve been surprised by the staying power of SPACs, given that they haven’t been producing big returns for investors,” Jay Ritter, a University of Florida professor behind the analysis of nearly 100 blank check listings, told Financial News.

Maybe that’s the hook. For investors, as a fad or as the next big thing, either way, they get a real say into whether or not the eventual merger interests them, Benjamin Kwasnick, founder of data provider SPAC Research also told Financial News. “If SPAC common shareholders don’t like the deal a sponsor presents, the overwhelming majority of them will happily take their $10 cash in trust back, plus interest, rather than stick around and hold on to shares in the acquisition target.”

Illustration by Christy Lundy

Andrew Seale

Andrew Seale is a Toronto-based business writer who contributes frequently to Yahoo Canada Finance, The Globe and Mail's Report on Business and The Toronto Star.