Making space for SPACs

Capital markets are fascinating. They are the arenas for gladiators to make and lose fortunes, all in the pursuit of business greatness. Traders in the stands mercilessly punish failure and support success, driving the gladiators to put everything on the line.

Investors seek out the gladiators with real staying power; the ones that have figured out how to survive multiple fights. The analogy sounds crude, but markets are rather savage at their core.

Stock exchanges usually offer arenas for established gladiators only. Those who have come through the lower ranks, supported by venture capital and private equity firms, may be ready to play on the biggest stages of all.

A SPAC, or Special Purpose Acquisition Company, is a gladiator that has a powerful track record, but has no weapons. The gladiator skips the B-circuit and rocks up at the arena, ready to beg the crowd for money to buy weapons and put on a show.

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How do SPACs work?

With this analogy behind us, let’s take a more serious look at the world of SPACs. They’ve been around for a few years on the JSE with varying levels of success. The structure allows a management team to come to market with little more than a business plan, raising equity capital from investors and kicking off a new investment holding company.

Essentially, investors are backing a management team with a dream and no money. It’s a far simpler way to list a company because the rules regarding profit history etc. obviously don’t apply, since the listed SPAC is just a cash shell.

A great success story would be the likes of Capital Appreciation Group which has become a genuinely interesting company on the JSE that I’ve written about before. An example of a failed structure would be Sacoven, the first SPAC on the JSE that listed in 2014 and gave the money back to shareholders in 2016 after being unable to execute a suitable acquisition.

The SPAC rules put the pressure on management to either find and buy a “viable asset” within 24 months of listing or return the capital to shareholders. It gives protection to investors against capital rotting in a bank account for years on end but doesn’t protect investors from a bad deal.

Shareholders must approve the first acquisition, but they depend on management’s ability to do a proper due diligence on a private company. This is a different situation to a traditional listing where an existing business comes to market after being scrutinised by professional advisors, accompanied by full disclosure of company history and the strategy going forward etc.

IPOs ain’t what they used to be

The process of bringing a company to market and raising capital is called an IPO (Initial Public Offering). It’s expensive and difficult and often isn’t the easiest way for entrepreneurs to realise value from a company.

It’s been a rather sad period on the JSE since the Dot Com bubble. In September 2002, there were 485 companies listed on the JSE. By the height of the Global Financial Crisis, there were 425 listed companies. There are now just over 340. The only sector that saw a raft of new listings over this period is the property sector, as REIT legislation allowed property funds to raise enormous amounts of capital from pension funds and other institutional investors.

Market consolidation is part of the downward trend, but so is a general lack of investor appetite for SA Inc. stocks (companies with only South African interests). Entrepreneurs are finding it easier to sell their companies to private equity firms or existing listed companies, rather than bringing new listings to market.

It’s not just here, though. Even in the US, the relative appeal of IPOs has decreased. They are onerous to execute and extremely expensive with advisor fees. Unlike in South Africa, SPACs have become a powerful alternative to raise capital on the US market.

CNBC quotes a Refinitiv statistic that there have been 67 SPAC offerings globally this year, raising a record $23.9bn. Importantly, this represents nearly a fifth of the total funds raised through IPOs this year (around $116bn). Of the 67 new SPACs, 61 are listed in the US. It’s clear to see where the action is.

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What’s in a name?

Chamath Palihapitiya doesn’t have the easiest name to remember, but he does have a ton of money and a proper track record. After an early stint at Facebook, he went on to put together a venture capital fund where he invested in companies like Slack and SurveyMonkey. It was a highly successful fund for investors and it turned Palihapitiya into a wealthy man.

Having proven his abilities in a venture capital context, he went on to list Social Capital Hedosophia Holdings in 2017, thereby ensuring that he had the most complicated email signature on the planet. The SPAC raised $600 million from investors, bought Virgin Galactic in 2019 and has achieved 60% share price growth since then.

With the taste of success still fresh, Palihapitiya went on to list another two SPACs in April. They are both targeting tech companies, but one is chasing a unicorn (valuation above $1bn) and the other is targeting a mid-sized company.

The SPAC model has clearly become his preference. His public view is that venture capital (VC) structures are less attractive because the management team has to spend time managing the investors in the fund. There are usually existing relationships between the management team and the key investors in a VC fund, whereas a SPAC is a publicly traded company and the shareholder register changes daily.

The other issue is that a SPAC gives the management team some space to go off and put the right acquisitions together. Hedge funds and VC funds are different – investors want immediate results because the life of the fund is often finite (usually 5 – 7 years).

SPACs are “evergreen” vehicles because investors can sell their shares to realise value, rather than relying on the fund to be closed. There is no end-date for the SPAC.

This also creates a situation where SPACs are not pressured to sell the underlying assets. Closed-end private equity and VC funds must dispose of the assets in time to wind-up the fund and return capital plus profits to investors.

There are clearly compelling reasons to consider a SPAC rather than a new fund.

Evolving regulations

In response to the SPAC boom, the New York Stock Exchange (NYSE) is trying to make it easier for existing companies to list and raise money from shareholders. This is to avoid a situation where companies wait around to be acquired by a SPAC vs. coming to market in the traditional way with a full profit history.

Whether or not the NYSE process will curb the popularity of SPACs remains to be seen. Palantir Technologies, Peter Thiel’s rather secretive data analytics firm, will list on the NYSE under the new framework. The real problem for the NYSE is that the Nasdaq gets the lion’s share of tech listings and that’s where much of the current activity is.

If South Africa gets its house in order, we may even see more SPACs on the JSE going forward.

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