If the optimists are to be believed, the "blank check" corporation may prove to be a viable financing vehicle that delivers private equity-like returns. Then again, it could also be the latest example of attempts that fail to bridge the gap between the public and private markets. With only a handful of successful deals so far, and few that have actually fulfilled their mandate, it is proving difficult to tell what the future holds for such structures.
As the name implies, the blank check IPO is nothing more than a shell formed with a mandate to use proceeds for undisclosed acquisitions, with little more known than the industry or region to be targeted. However, unlike these deals’ precursors, which elicited the attention of securities regulators in the 1990s amid “pump-and-dump” schemes, the latest iterations of blank checks are structured with investor protections.
Most significantly, in a SPAC (Specified Purpose Acquisition Company), as the new derivation is generally called, the majority of the IPO proceeds are escrowed until an acquisition is completed. If a target is not found within 12 months, the escrowed proceeds must be returned to investors on a pro rata basis. The escrow is generally 90% of the amount raised on the IPO.
The SPAC format requires that the company seek stockholder approval for acquisitions, and that the size of the purchase comprise 80% of escrowed assets. If more than 20% of shareholders vote against an acquisition, then it cannot be completed. Even if the hurdle is met, dissenting shareholders are rebated the escrowed proceeds on a pro rata basis.
International Shipping Enterprises (ISE), the largest entity to use the structure so far, showed how to navigate successfully the regulatory and operational intricacies of the SPAC. Formed in September 2004 with initial backing from industry insider Angeliki Frangou, the company landed an additional US$196m three months later in its IPO. The placement of 32.8 units, each consisting of one share of common stock and one warrant, was priced at US$6.00 and conducted through Sunrise Securities.
ISE had signed a letter of intent to acquire Navios Maritime Holdings, a dry-bulk shipping concern, in February. By August, the company had received the necessary shareholder approvals and, together with borrowings on a US$520m secured credit facility, the escrowed proceeds were used to fund the US$607.5m purchase price.
The transaction proved that the private-to-public market arbitrage evident from buyout activity could be made available to smaller institutional and retail investors. “We got the block at a cheap price,” said one source at Kennedy Capital Management, an independent investment adviser that focuses on small-cap companies. “It wasn’t on people’s radar screen – there weren’t a lot of people following it or hyping it.” ISE units and warrants, which trade on the OTC bulletin board, were recently quoted at US$5.80 and US$1.15, respectively, down from highs of US$7.04 and US$1.96.
Eagle Bulk Shipping, another dry-bulk carrier, held its US$201.6m IPO in June, less than six months after its formation by Kelso Investment Associates, a buyout firm. As the trend continued with the IPO of Quintana Maritime, a portfolio company of First Reserve, public investors began to question valuations above NAV of ships that had only been recently acquired.
In this context, ISE was seen as a seminal transaction. “The market has become more accepting of SPACs as a way of putting capital to work for acquisitions similar to an LBO or buyout fund,” said Cynthia Krus, a partner at law firm Sutherland Asbill & Brennan. "The acceptance of this vehicle is attributable to experienced management teams and a greater variety of sponsorship from investment banks.”
A long way to go
Still, only eight companies have raised US$582.6m through blank check IPOs so far this year, and none of these has yet signed any acquisition agreements. With the exception of Morgan Joseph, which handled a US$120m offering for Stone Acquisition Corporation (an entity headed by former Smurfit Stone Container CEO Roger Stone) and Wedbush Morgan, even the banks handling the offerings are hardly recognisable as ECM regulars.
EarlyBird Capital, a five-year-old firm that credits itself with developing the SPAC moniker, has been involved in half of the offerings so far this year, the largest of which was a US$120m sole-bookrun mandate for Courtside Acquisition Corp. David Nussbaum, EarlyBird's chairman and founder, and Steven Levine, its CEO, both hail from GKN Securities, a now defunct brokerage that underwrote blank check offerings in early 1990s.
The last run of blank check deals largely came to a halt in 1997, when the NASD ordered 29 GKN brokers to pay more than US$2m in fines and restitution to settle allegations that they had overcharged investors in the trading of eight stocks. The regulators alleged that GKN charged excessive mark-ups through control of the post-IPO trade in the securities, many of which were blank check offerings underwritten by the firm.
There are clearly reasons to question the legitimacy of the blank check format. Some 32 companies (US$2.3bn) have registered offerings in the wake of the ISE transaction. With acquisition mandates running the gamut from technology and healthcare to country-specific, or frequently nothing specified at all, the growing backlog has aroused the concern of securities regulators.
SEC officials have responded by lengthening the review process, according to market participants, and by standardising the language used in prospectuses. The structure itself appears to thwart the measures put in place by the SEC in the late 1990s to protect investors.
Rule 419 of the Securities Act stipulates that all – not just a portion – of the offering proceeds raised from blank check issues should be placed in escrow until an acquisition is consummated. In addition, trading in the security cannot take place until completion of the acquisition.
The rule, however, does not cover issuers whose outstanding shares are not deemed to be penny stocks – generally defined in the US market as a share price of at least US$5, for a company with net assets of at least US$5m. Pricing at US$6–$8 per unit neatly circumvents the first rule, and an 8-K filing to reflect the receipt of IPO proceeds suffices the second requirement.
An OTC listing, which requires underwriters to seek registration and trading approval under the Blue Sky provisions of individual states, is problematic to establishing trading liquidity. In the case of ISE, for example, Sunrise secured approval to distribute and establish a market in just 10 US jurisdictions. Issuers appear to be circumventing these requirements as well.
The AMEX recently approved some SPACs, including Courtside Acquisition, to list on the exchange, a designation that automatically pre-empts the need to gain regulatory clearance in individual jurisdictions. “There have been discussions between the SEC and AMEX officials,” noted one securities lawyer. “The exchange listing takes away the ability to regulate them on the front end,” added the source of recent concerns by state securities regulators to the rubber-stamp approval.
Potentially in response to such considerations, and also to make the deals more marketable, investment banks such as Ferris Baker Watts have recently offered to waive a portion of their underwriting fees until the IPO issuer has completed an acquisition. In the case of a US$120m IPO for India Globalization Capital, the regional bank deferred US$6.6m of its US$9m, 7.5% gross spread. Similar provisions exist on proposed offerings by Cold Spring Capital and JK Acquisition.
It only makes sense that investors would push back against such sizeable underwriting fees. Lower proceeds immediately erode the firm's buying power and, if unsuccessful, a smaller investor rebate on the back end. A similar thought process derailed the business development corporation (BDC), a tax-advantaged corporate structure that lends and invests largely in small, private companies, as the latest investment vehicle to bring private equity expertise into the public markets.
Apollo Investment Corporation, an affiliate of buyout giant Apollo Management, was the first to use the BDC structure when it raised US$871.9m – after a 6.25% underwriting fee – in April 2004. Countless other buyout firms, including Kohlberg, Kravis Roberts and Blackstone Group, have stumbled on attempted BDC IPOs, largely because of fees. None of the attempted BDC IPOs has been reborn as a SPAC, although industry participants are hopeful of such an endorsement.
And that endorsement might have to come from the large investment banks. CSFB and Banc of America are heard to be pitching SPACs as a potential financing vehicle to financial sponsors. One factor likely to limit buyout interest in SPACs, however, is the requirement to acquire one or more operating businesses that have at least 80% of net assets through a single business combination.
“There was a fairly respectable buyout firm that asked us to look into whether this [a SPAC offering] was feasible,” said one bulge bracket banker. “But blank checks have had a pretty shaky past and it might be a while before any activity.”