SPAC: What Are ‘Blank Check’ Companies?

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SPAC is short for a special purpose acquisition company, also known as a “blank check” company.

A SPAC is essentially large pool of cash, which is listed on a public exchange with the sole purpose of completing an acquisition. It’s essentially a form of a backdoor IPO.

SPACs are unique in that they have no pre-existing business operations or even a particular target company in mind to acquire. If they do have a target firm they’re looking to acquire, they won’t identify what it is.

Investors in the IPO are not aware of what company they’ll be investing in. They’ll typically make a determination of whether to invest in the SPAC based on their trust in the particular investor/entity seeking to make the acquisition.

So, naturally, SPACs tend to be headed by popular investors such as activist investor William Ackman or former Citigroup banker Michael Klein.

SPAC funds are placed in a trust account and will typically bear interest. The interest accumulated will normally be returned to investors at some point or be used to help fund the operations of the target company.

The blank check structure is not a new concept, having gone back to at least the 1980s. Back then, they were commonly populated by lower-quality or even fraudulent companies.

These days, they are often backed by white shoe investment banks, including Goldman Sachs, Morgan Stanley, JPMorgan, and other prominent investors, and listed on leading exchanges like the NYSE or NASDAQ. Goldman underwrote its first SPAC IPO in 2016.

They are traditionally popular in the TMT space (technology, media, and telecommunications), healthcare, and retail.

 

The Covid-19 Influence

The coronavirus crisis and its economic fallout have created a new wave of interest in the investment vehicle. With a market that’s been racked by volatility and larger-than-normal unknowns, it’s become a more attractive way of going public.

Backers of new SPACs are often looking for distressed companies to acquire (from the pandemic fallout) or those in compelling growth verticals. The pandemic itself has also shifted the S curves of some business trends.

Going the SPAC route is often quicker and more reliable than going public through a traditional IPO.

Deal terms are negotiated between the target company and SPAC. A company knows how much capital it’s raising early in the process rather than toward the end, like in a standard IPO where underwriters go back and forth with investors until right before the company goes public.

IPO deals can also be shelved if markets tumble, public-market interest is likely to be subpar, and new investors aren’t likely to buy in at a high enough price point to make listing worth it.

When a SPAC buys a target company, it gets listed on the exchange.

Electric vehicle (EV) startup Nikola (NKLA) went public via a SPAC sponsored by a former General Motors executive. It saw success right off the bat, temporarily receiving a higher market valuation than Ford (F) despite not having a product or any revenue, and greatly outperforming in percentage terms.

nkla vs ford

 

nikola spac

(Source: YCharts)

 

EV manufacturer Fisker also went public through a SPAC.

Many prominent investors have used blank check vehicles with the open-ended goal of acquiring a target. Pershing Square Tontine Holdings is set to be a $3 billion IPO, the largest SPAC ever. With additional funding, it could have up to $6.5 billion. This could potentially involve an IPO of a private firm worth north of $10 billion.

These blank check vehicles have no operating history when they go public. They are contractually mandated, usually within two years, to use the proceeds of the IPO to acquire or merge with a target company. If they don’t, the funds must be returned to the public.

We’re also in an environment where there’s a lot of liquidity from central banks propping up the economy from the Covid-19 destruction. Naturally, this bids up asset prices.

When there’s a lack of compelling forward returns in traditional asset classes, investors increasingly go searching for alternatives wherever they can. This is helping to popularize the SPAC structure. Governance of the blank check structure is also regulated lightly and major investment banks have used the structure to help investors access capital financing.

New SPAC listing totaled over $12 billion in the first half of 2020. The debut of Pershing Square’s SPAC will break 2019’s annual record of $13.5 billion.

Richard Branson’s Virgin Galactic Holdings (SPCE), a space tourism venture, went public via a SPAC. Online gaming is also a popular blank check vertical, with DraftKings and Golden Nugget Online Gaming going public via the structure. Twenty companies went public via SPACs in the first half of 2020 with their aggregate market valuations totaling some $45 billion.

 

SPAC Risks

A SPAC boils down to an abbreviated IPO process with fewer disclosures. This subjects blank check companies to less scrutiny, creating potential risks for investors who have less information on which to base their decisions.

In some cases, SPAC investors often take a large amount of the equity in the business they acquire, often upwards of 20 percent, even if the target company sees its value dip once public.

In others, the SPAC and target company will better align incentives between them, allowing the SPAC to buy shares if the firm rallies by a certain percentage.

This incentivizes investors to only go after the best possible targets and not simply invest in anything that would effectively guarantee a return in some form. This arrangement also ensures that the target firm has a “true partner” backing them.

 

Differences between the US and European markets

During and after the Covid-19 crisis, the SPAC blank-check concept was one of the drivers in US equity market activity.

Traditional IPOs were effectively shut down with a compression in prices/valuations and volatility. Every company obviously wants their IPO to be a success to obtain the best value for any shares they release to the public.

If the general environment is bad, then companies are more inclined to stay private or will seek out alternative arrangements, like SPACs.

In major European hubs like London, the blank check structure is uncommon and Europe didn’t benefit from the activity as they did in the US.

 

spac blank check us vs europe

 

As a result, European exchanges are looking for ways to ignite more interest in these offerings where investors can vote on an acquisition target from the pool of collected funds.

Investors in SPACs in the US vote on the acquisition and redeem their money if they don’t like the deal. However, in the UK, investors are not permitted to trade a SPAC’s shares from the time a deal is announced to approval of the prospectus.

That means investors can be tied into an acquisition they don’t approve for an extended period of time. The difference in these rules accounts for the relative attractiveness in the US SPAC market versus the tepid European one.

 

Conclusion

A SPAC is used as an investment vehicle to raise money to buy another company in the form of an IPO.

At the onset, these blank check companies have no business operations or any deal in place to acquire a company, or even a known list of targets. They must typically make an acquisition within two years or have the SPAC liquidated with funds returned to investors.

All types of investors can be involved in SPACs, though they are typically private equity firms or hedge funds given the need to acquire a “late stage” firm looking to enter the public markets.