By Damien Park, President & CEO Hedge Fund Solutions, LLC
1/22/2009
Last year was tough for special purpose acquisition companies (SPACs), and 2009 is shaping up to be even more difficult.
These relatively obscure investment vehicles are usually formed by a group of managers with operating or investment experience who raise capital through an initial public offering (IPO). After the offering, a majority of the proceeds are held in an interest-bearing trust account until the consummation of a business combination with an operating company.
If the scheme works as intended, SPACs can generate above-market returns for investors by expeditiously moving an undervalued private company onto a major stock exchange. Shareholders get to participate in a reverse-merger IPO with tremendous upside potential and management is rewarded with a substantial ownership stake in the new entity.
Alternatively, if management fails to identify an acceptable acquisition candidate, usually within 24 months of the IPO, the entity must be liquidated and all of the cash held in trust is distributed back to shareholders. Since insiders do not participate in the liquidation distribution, management receives nothing.
As private companies find it harder to access capital from frozen credit markets, tapping into the equity marketplace through this reverse IPO process can be very appealing. However, depressed stock market valuations have squashed many of the incentives for a private company to "go public" any time soon.
During 2008, 21 SPACs were forced to liquidate because they ran out of time to complete a transaction. For the SPACs that found deals, the market was unforgiving, punishing shareholders an average of 60% from their IPO debut.
All of this doom and gloom is creating a steep discount between the stock price and the cash value at 47 SPACs with a combined $10.3 billion in acquisition capital. In 2009, 34 of these companies must find suitable acquisition candidates or face liquidation.
This has captured the attention of activist investors, who see an opportunity to generate high returns by forcing these companies to liquidate sooner rather than later.
One activist investor,
Well-informed investors recognize that every SPAC is trading at a discount to its cash value and, if liquidated, will generate a return on investment proportional to the discount.
If management proposes a deal before the liquidation date, a shareholder has two excellent options. If the transaction is clearly remarkable, the investor can approve the transaction by voting in favor of it. If not, he or she can vote against the transaction and redeem ownership for a pro rata share of the trust account. Either way, there is a high probability the discount-to-trust will close.
However, if 20% to 40% of the shareholders vote against the transaction and request their money back (this threshold depends on the company's bylaws), the deal is scuttled and the SPAC will likely liquidate within a couple months.
Activist investors have identified this as a chance to boost returns. Better than anyone, they know how to turn a company's governance rules, like supermajority vote approval for transactions, to their advantage. By gaining control of enough shares to block any acquisition and demanding early termination, activists leave management with very few options or than liquidating.
In a recent example, Goldstein picked up an 18.5% stake in TM Entertainment and demanded that it liquidate immediately. He needs support from just another 11.5% of shareholders to block a transaction, and he says there is virtually no chance that TMI can complete a business combination by Oct. 17, 2009, when a forced liquidation must occur. In an effort to hurry things along, Goldstein is trying to gain control of the board to prematurely liquidate the trust.
If liquidation takes place or a deal is successfully blocked by shareholders, TM's management must forfeit approximately $2.5 million of their personally invested capital in the SPAC along with the 20% ownership stake that they would obtain in the post-acquisition company. As a result, management is pleading with shareholders to vote against Goldstein's takeover attempt.
The magnitude of the losses to management might predict a fierce and costly fight. However, unlike operating corporations, SPACs can't fight back using corporate money.
According to their bylaws, SPACs' funds are limited to working capital, taxes and moderate salaries. Legal and proxy battles, therefore, must be paid out of pocket by management, creating an equal playing field with someone like Goldstein who has long opposed the use of shareholder money to fight dissidents like him.
It's hard to say which SPACs might be raided. All SPACs seeking acquisitions have significant exposure and limited firepower. For investors, even without an activist forcing liquidation, the value appreciation opportunity seems solid. But in 2009, we'll likely see many of these companies under considerable pressure to return their cash to investors sooner rather than later.
Special Purpose Acquisition Companies (SPACs)
(Source: Morgan Joseph SPAC Update)
| SPAC | Ticker | Liquidation Date | Discount to Trust | Activist(s) in Shareholder Base |
| Alternative Asset Mgt. | AMV | 08/02/09 | 4.2% | Yes |
| Atlas | AXG | 01/26/10 | 8.0% | Yes |
| BPW | BPW | 02/28/10 | 8.5% | No |
| Global Brands | GQN | 12/08/09 | 7.4% | Yes |
| Golden Pond Healthcare | GPH | 11/08/09 | 7.1% | Yes |
| | HIA | 10/04/09 | 6.2% | No |
| MBF Healthcare | MBH | 04/23/09 | 2.5% | No |
| Media & Entertainment | TVH | 03/13/09 | 2.0% | Yes |
| NRDC Acquisition | NAQ | 10/19/09 | 6.5% | No |
| NTR | NTQ | 02/01/09 | 0.9% | No |
| Prospect | PAX | 11/16/09 | 6.9% | No |
| | MEJ | 03/29/09 | 2.4% | No |
| Sapphire Industrials | FYR | 01/19/10 | 7.5% | No |
| SP Acquisition | DSP | 10/12/09 | 7.0% | Yes |
| TM Entertainment | TMI | 10/19/09 | 5.9% | Yes |
| Trian Acquisition I | TUX | 01/24/10 | 7.8% | Yes |
| Triplecrown | TCW | 10/25/09 | 7.0% | Yes |
| United Refining Energy | URX | 12/12/09 | 6.9% | No |
| Victory | VRY | 04/26/09 | 3.1% | Yes |
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