Thursday, June 28, 2007

Spac Structure

Below is a rundown of the typical Spac structure, variants do exist though: be sure to check the S-1. In fact, it’s usually Spacs with unusual features that make good investments. That's why Baupost probably went for Star Maritime Acquisition (SEA) (links to Value Investor Club write up, membership required).

Spacs are sold in “units”, which are composed normally of one common stock and one or two in-the-money warrants. Check in what kind area the Spac is looking to make a deal in, what the composition of the units are, and how many are being sold to the public. You also want a solid management team; that’s who you are betting on to go get an acquisition together.

You can find what Spacs are coming to market by going to the SEC website and doing an Advanced Search under S-1 filings in Form Type. In “Search for Text” type “blank check company”.

Sometimes, the underwriter will defer all or part of their IPO fees (usually 6% of market cap) and wait till an acquisition/merger is sealed before collecting. This is likely to also put pressure, or incentivize (depending on your perspective), management to bag a deal - it's hard to imagine iBankers doing a deal if they didn't think there would be some fee payoff.

In addition to funds raised via the IPO of units, management typically buys 20% of equity in a private placement, which may or may not be in the form of common stock or warrants, and normally sold at way below the public offering price of the units. Yes, they benefit a disproportional amount if a deal pulls off, but then they have to go scour for the deal plus warrants cannot be exercised until a deal has been completed. Management's warrants sometime come with a 2-3 year lock-up. Basically, this prevents them from off-loading and doing a runner if they get bored.

In some cases, management must buy warrants at a set price on the open market, supporting warrant prices for investors, and ensuring management has more of their money on the line. Management thus has some “skin in the game” whatever the flotation's intricacies.

Spacs are working against a ticking clock, they must seal a deal in 18 months with a 6-month extension if a deal has been announced but not completed within the initial 18 months.

Also it is normal for at least 85% of proceeds from the IPO to be kept in trust, so management can't cane the money on margaritas and lap dancers in Cancun. So while management are hunting for a target the cash accumulates interest, although not always at full money market rates – you need to check the interest payments in the financials to gauge what the trust acct pays.

Theoretically, the money in trust is safe… but it has been pointed out those funds may not be immune to third party claims and shareholders claims may be secondary to other claimants. That having said, I haven’t heard of a case where a Spac has been successfully sued over funds in trust and if the Spac is purely equity-financed its hard to see who else is likely to be above the shareholders in terms of claimants. (If you know of any incidents where shareholders claims have been made secondary to another party, or the funds in trust have been subject to third party claims PLEASE LET ME KNOW).

Once a deal is announced management needs 80% (exceptions exist though) of shareholders backing. The Spac must also use up 80% of cash in their trust for the deal. If a proposal is rejected the Spac shareholders can also force the vehicle to liquidate.

While it is rare, investors have shot down deals before. In December 2006 investors at TAC Acquisition Corp (TACAU) gave the thumbs down for an acquisition of Aviel Systems. In February shareholders approved a dissolution of the company. Obviously, the warrants went up in smoke as they were contingent on a deal being sealed, but the common stk got reimbursed. Holders of common stock received $5.6941 in cash per share; units had originally gone for $6.

Nonetheless, even if YOU don't like the deal and it still gets an 80% thumbs up from other investors you can still cash out (assuming you hold common stock in the Spac) and receive cash in proportion to your slice of funds in the trust. There may be some charges however if the deal receives shareholders' blessing but you decide to liquidate.

One issue which I'm not entirely sure on and would be interesting to check is if you decide to liquidate in the event a deal goes through and you are still holding the original units, presumably your common stock is dissolved but do you still get to hold onto your warrants? Does anyone know?

Anyway, that's the basic lowdown on Spac structure. If you're interested in a much more detailed breakdown of Spacs then check out this link.

In the next post I'll look at why value investors may be interested in these vehicles.


Rachel said...

how do i contact you to discuss a certain spac

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