The Covid-era boom in SPACs – special purpose acquisition companies – reflects private equity investors’ search for better returns in a low-rate world.
The new big-money status symbol of 2020 is running your own blank cheque company. Hedge fund billionaire Bill Ackman has a new one. Oakland A’s executive Billy Beane, who was played by Brad Pitt in the film Moneyball, got into the game with an IPO in August. Even former U.S. Speaker of the House Paul Ryan is getting one going.
So what’s a blank cheque in this respect? Formally known as a special purpose acquisition company, or SPAC, it’s an investment vehicle that goes public despite having no real business. The plan is to raise money from investors and use it to buy into another company, typically a private one that’s yet to be chosen.
More than 40% of 2020’s IPOs by volume have been SPACs, raising $31.6 billion, more than double all of last year’s volume of $12.4 billion. And last year was a record breaker, too. “Three to four years ago, SPACs were just a curiosity,” says Niccolo de Masi, chief executive officer of two blank cheques, DMY Technology Group Inc. and DMY Technology Group Inc. II, that together raised more than $500 million. “Now it’s an option for everybody.”
The blank cheque boom – or maybe fad? – stems from the collision of two big trends: The first is historically low interest rates. With safe bonds paying less than 1% and stocks trading at high valuations, more investors are willing to park their money with a SPAC in hopes of getting lucky with an acquisition that pays off big.
Second is the long-running boom in private equity and venture capital. Investors who poured money into buying companies over the past decade want to cash in by selling them. So, there are plenty of companies for SPACs to buy. Add to these an old constant: financiers looking for new ways to earn a fee from a transaction.
But as with any new venture, risks lurk beneath the glossy surface. Identifying and mitigating such risks are bread-and-butter to procurement professionals. Any systemic exposure of investors’ cash to errant or unreliable investment vehicles carries untold risk to all who manage a private equity company’s portfolio.
In the heady world of major-league PE investment, with its attendant stratospheric stakes, bruising boardroom bash-ups and share price gyrations, shouldn’t procurement professionals’ prowess be an integral part of any investors’ assessment of operational efficiencies?
This ties in with revelations in accounting firm Ernst & Young’s recently published fifth annual survey of private equity CFOs. It reveals that record inflows to private equity funds over the past few years have put strain on operations for all involved, no matter the fund size or geography.
For funds both large and small, heightened competition and investor demand mean that margin erosion is now a constant threat. (73% of CFOs surveyed said their firms have experienced investor pressure to reduce management fees.) In this environment, CFOs have become increasingly focused on improved operational efficiency in private equity – leveraging both technology and outsourcing – as a barrier against shrinking profits.
The key findings of the EY survey in terms of operational efficiency are:
- Fund accounting is a low-value activity for in-house talent
Across the board, private equity CFOs agree that they would prefer their teams spend time on strategic, value-added activities – for example, portfolio analytics and investor relations. More routine operational areas are generally viewed as cost centres, but still take up a large portion of managers’ time and attention.
When EY CFOs were quizzed “Where do you want your teams spending time?” fund accounting was the least popular answer of those given. Outsourcing can allow internal teams to be more strategic.
- Technologically, private equity has been slow to catch up.
It’s clear that CFOs would like to spend less human capital doing fund accounting and more capital on improving operational efficiency in private equity. The most obvious way to achieve this would be through some sort of automation or streamlining technology.
However, when EY asked ‘What areas are most challenging to implement technology systems in?’ fund accounting led the group, meaning CFOs see fund accounting as the most difficult area to automate.
According to the EY authors ‘the technology infrastructure of many private equity firms lags that of their peers within the financial services industry (banks, diversified asset managers, etc.).’
- Spreadsheets are passé
According to the survey, ‘CFOs have come to realize that manual data entry and reporting via spreadsheet are not an effective use of resources.” In fact, nearly 80% of CFOs said that use of spreadsheets as data sources was a top management concern.
- Automated investor reporting is the way forward
In today’s climate, satisfying investor requests for financial data is one of the most difficult areas in which fund managers struggle to manage costs. For smaller firms in particular, investors’ expectation of on-demand access to fund information can be onerous.
To the survey question ‘What automated technology solutions would most benefit your accounting team?’ more than half of respondents put investor reporting at the top of their wish list.
While the automation of data reporting to investors is tempting, CFOs remain concerned that this will sacrifice flexibility, reducing investor satisfaction.
In relation to the ‘new normal’ method of raising funds, the pandemic-induced market volatility in March, which made it difficult for conventional companies to go public, helped bring SPACs into the spotlight. Being bought by a SPAC can be an easier way for a private company to go public.
It can skip the usual roadshow for pitching investors and avoid some of the scrutiny that goes with an IPO. Online sports betting company DraftKings Inc. became a public stock in April after completing a merger with Diamond Eagle Acquisition Corp. in a $3.3 billion deal.
As is customary in such ‘reverse mergers’, the SPAC took the name of the business it bought. When the stock price popped from around $10 a share for Diamond Eagle before it announced the deal in December to a peak of $43 in June as DraftKings, it helped add to the buzz around blank check deals.
Investors seem particularly fascinated with the latest blank cheques because they’re getting into futuristic businesses. Luminar Technologies Inc., a Peter Thiel-backed company that develops the sensor technology behind driverless cars, announced plans to merge with a SPAC on Aug. 24. The Richard Branson-founded space tourism company Virgin Galactic Holdings Inc. went public via a blank cheque in 2019.
But the investors who fund SPACs when they first go public aren’t necessarily counting on moonshots. They’re typically institutions such as hedge funds, and the companies offer them the combination of a relatively small downside with a chance to make a tidy profit down the road.
Blank cheques typically go public at $10 a share and have 24 months to find a target. If the company fails to identify one, it liquidates, and investors get their money back. Investors also get to vote on a deal and have a chance to redeem their shares whatever the result.
For that reason, SPACs tend to trade around their $10 price until a deal is announced (or sometimes rumored). In addition, the initial investors in a SPAC get warrants, which entitle them to buy more shares at a set price after the company makes an acquisition.
SPACs aren’t riskless, though; particularly if you buy after a deal is announced and the stock has soared above $10. And once a deal is finalized, the shares can fall below that price as easily as any other stock’s. Of the 18 companies that went public via SPAC mergers in the past year, 11 are trading for less than $10 a share. SPACs are partly a bet on the skills of the sponsors who lead the companies while hunting for a target – often money managers or well-known executives.
Even the most prominent sponsors can have flops. As with private equity and hedge funds, one of the best ways to make money on a SPAC is to start one. As part of their compensation for finding a company, sponsors are generally able to purchase 20% of the SPAC’s stock for a very small amount, typically $25,000. They are also offered warrants.
That means they end up getting a chunk of the shares of the company the SPAC acquires for very little money. Because their compensation dilutes the value of shares, it’s part of the cost to a company of going public through a SPAC deal, offsetting some of the fees it saves by not doing a conventional IPO.
Ackman is taking a different route with his newest SPAC, Pershing Square Tontine Holdings Ltd. In essence, his compensation will kick in only when the merged company trades 20% above the offer price. Pershing Square Tontine is the biggest SPAC to date, having raised about $4 billion. Ackman says he wants to buy a minority stake in a ‘mature unicorn’ – a private company with a valuation of $10 billion or more.
Currently there are 120 SPACs with $40 billion to spend, according to data from SPAC Research. DMY Technology’s de Masi predicts that the market will soon split into two categories: a few top sponsors able to make attractive mergers and everyone else.
That doesn’t mean the stars won’t have competition. On Aug. 24 four software companies announced plans for traditional IPOs, and another, Asana Inc., said it would do a direct listing – that is, go public by making existing private shares available to trade on exchanges rather than selling new shares. Thiel’s Palantir Technologies Inc. filed for a direct listing the next day.
Investors may soon find out whether SPACs are a new way of doing business or just the latest shiny object in a bull market. In which case, acknowledging how critical is managing the risk of investing clients’ money in SPACs as the ‘new normal’, PE firms could turn to procurement specialists’ expertise for some cautionary advice and shrewd insights. After all, the most expensive commodity to buy – and lose – is money.