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Holy SPAC! Haven’t we seen this before?

April 13, 2021

……the combination of market hype, low yields and celebrity endorsement all point to a substantial risk of major losses for some investors……

A SPAC or “special purpose acquisition company” is described by the US SEC as “blank cheque” company.  A SPAC is a cash-rich shell formed to identify and execute on a merger or acquisition with an unidentified company or companies. These ready-made cash boxes can presumably swoop on opportunities without drawn out fundraising IPO processes.

The SPAC generally banks funds raised (after fees) in a trust account until an opportunity is identified. In theory, the SPAC will refund investors’ money (after fees and taxes plus interest) if a suitable opportunity isn’t found. If an opportunity is found, a “business combination” takes place between the SPAC and its targets and investors have the usual exit mechanisms of a listed entity.

The concept of investors placing blind trust in other people to take care of their money is not new, it is very similar to how most fund managers operate. However, the listed market element does seem to have some merit from a future liquidity perspective. Its like a pre-packaged private equity fund that rolls-up a bunch of businesses and then floats on a stock exchange.

In the US

SPACs are listing in the US in huge numbers and the 2020 / 2021 growth of SPAC IPOs seems fever pitched both in size of IPOs and value of money raised. In 2020, $83b was raised into SPACs, and 2021 has achieved almost $100b in the year to date. They are available to US retail investors.

In dealing with the rise of SPACs, the SEC has issued a bland bulletin with a series of warnings (see here). The warnings seem relatively standard: read the prospectus, understand how the cash is held, be aware of the time frames for which the SPAC can consummate a deal and understand the terms of issue of the deal (for example any warrant rights).

More recently, the SEC has raised alarm bells about the growing number of celebrities spruiking an association with a SPAC fundraising. The SEC observed “celebrities, like anyone else, can be lured into participating in a risky investment or may be better able to sustain the risk of loss. It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.”

The SPAC market will have some winners and a few blue-ribbon fund managers have joined the list of SPAC promotors. The Pershing Square Tontine SPAC was one of the largest raises across US IPO markets in 2020 with $US4B raised.

However, the combination of market hype, low yields and celebrity endorsement all point to a substantial risk of major losses for some investors. This will inevitably come from illogical capital flows to poorly credentialed “me too” sponsors with limited or no funds management skills.

In Australia

The media suggests the ASX is mulling over whether to admit SPACs on the ASX with some suggestion of hesitation.[1]  That being said, we have had a long history of this type of entity albeit under a different name – a “cash box”. Dating back to 1999, ASIC issued disclosure guidance [RG 70] Prospectuses for cash box and investment companies. ASX guidance remains on foot (although it needs an update) and it highlights a couple of critical issues off the back of heightened growth in cash box companies. These are:

  • Quality of management: “An investment in an enterprise that has no investment plan or only a partially developed investment plan is an investment in the skill and expertise of its directors and management. In these circumstances we consider the only means by which an investor can make an informed assessment about the prospects of the company or scheme is if they are provided with factual information about the expertise of those persons who will make the investment decisions.” [RG 70.3]
  • Disclosure of Risk:  “Those matters associated with the investment strategy which remain unresolved at the time of lodgment of the prospectus can be characterised as risks associated with the proposal. We expect such risks to be explicitly identified and discussed in the prospectus.” [RG 70.8]

Pre-GFC saw a few cash boxes hit the ASX and one of the most notable Australian cash boxes was Allco Equity Partners (AEP) created and managed by its collapsed namesake. In December 2003, The Age reported about AEP “The prospectus was oversubscribed, raising $550 million, and … another $450 million had to be sent back to shareholders who rushed the prospectus.”[2] AEP issued a $6 share paid to $2 and by 1 November 2006 had collected the full amount of capital with over $600m in assets on its balance sheet. Mixed success in acquiring some public companies (including Qantas Limited) followed. Ultimately, it was an unhappy story for investors and in its last set of audited financial accounts (2019), AEP (under its new name) reported around $170m in accumulated losses before it was shut down and de-listed.

What goes around comes around. SPACs are popular now, in the same way cash boxes enjoyed spectacular support pre-GFC.

[1] https://www.afr.com/chanticleer/spac-fever-reaches-australia-but-the-asx-is-cool-20210314-p57ajt

[2] https://www.theage.com.au/business/allco-equity-float-barely-makes-ripple-on-asx-20041223-gdz8w3.html

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