By Gan Kim Khoon
Director and Regional Head (Equity Capital Markets), Corporate & Investment Banking Services at RHB Investment Bank Berhad
Regulatory authorities that approve and introduce new financial instruments and products into capital markets share three common objectives:
- To increase the depth of capital raising capacity so that the business sector can fund growth;
- To excite investors and invigorate the market; and
- To create shareholder value.
In introducing new instruments, the intent is to bring variety and vibrancy into financial market activities, while safeguarding investors’ interests and promoting confidence. In that respect, the Special Purpose Acquisition Company (SPAC) instrument introduced by Malaysia’s Securities Commission (SC) in 2009 is no different from any other financial instruments introduced by the SC in the past.
SPACs are a well-established instrument designed to help entrepreneurial, skilled management teams to start new businesses and can represent high-returns investment instruments for public investors at the earliest stage of value creation.
As an example, in December 2006, leading clothes designer American Apparel was sold to Endeavor Acquisition for US$384.5 million. Endeavor Acquisition was a SPAC.
Similarly, in April 2012, Justice Holdings Ltd acquired Burger King Worldwide Holdings which has more than 12,500 restaurants across the world. Justice Holdings was a SPAC which raised £900 million in its February 2011 initial public offering in London.
Clearly, the SPAC model can and does work.
Media reporting and investor concerns on SPACs as asset-less and speculative investment vehicles by nature are understandable but miss the point entirely: namely, SPACs are a promising new investment platform for investors having a stronger risk appetite and looking to get into an investment at the early stage. Furthermore, the SC casts greater scrutiny on SPAC Initial Public Offerings (IPOs) than on traditional asset-based IPOs, if only to provide greater assurance to investors.
Malaysian SPAC model features strong regulatory safeguards
SPACs create instant valuation multiples for investors when it acquires a private operating business and immediately becomes an operating company. They should not be in any way compared with the now notorious “blank cheque” stocks that wreaked havoc and fraud in US securities markets in the 1980s, when very little oversight and enforcement were applied. The Malaysian SPAC model features strong regulatory safeguards – including trust accounts for the IPO proceeds, a set three-year window to complete the necessary due diligence for a Qualifying Asset (QA), longer than normal management share lock-ups and the requirement of SC and shareholder approval for any QA to protect minority investors. The SC’s intent to protect investors leads to SPACs having a tougher time at proving themselves worthy of listing. And those that do list are essentially value options with well qualified management teams, great upside and with strong investor protection.
When looking at buying into a SPAC, investors need to concentrate on three key considerations.
(1) Low-Cost Entry: Imagine being offered the opportunity to buy into Facebook when Mark Zuckerberg was still in his Harvard dormitory (or Bill Gates or Steve Jobs, for that matter). Unlike traditional IPOs which bring established capitalised assets, employee productivity and revenue streams to the market, SPACs offer investors a unique opportunity to buy into a company at the beginning of its business development and growth cycle. Precisely because they hold no assets at the time of listing, SPACs present a unique opportunity for retail investors to participate in the start-up of established and operational private companies that are usually only accessible by private equity or hedge funds.
(2) The Management Team: The founding stockholders or promoters, who usually hold up to a 20% stake in SPACs, are the “brain trust” and the most important asset of SPACs. As the management team, they bring to the table a unique blend of first-hand industry knowledge and experience, asset transaction and risk management expertise and experience, their own entrepreneurial zeal and profit motivation and a proven track record of creating value for shareholders that will ensure that their SPAC is ultimately a success. Although all SPACs have differencing strategies, SPAC founding stockholders must bring together a distinct combination of industry experience, market knowledge and a proven track record of creating shareholder value. This combination of proven and successful skills is difficult to replicate and remuneration is and should be commensurate with these key skills sets along with the degree of rarity of such skills and the ability and track record to deliver value to shareholders. When Silicon Valley start-ups go on fund raising exercises, private equity investors and venture capitalists routinely acknowledge the need to award start-ups’ founders with salaries and other remuneration that matches the risk in building companies from scratch and rewards the delivery of shareholder value while balancing founders’ normal open market remuneration packages. Balancing the founder’s risk/reward profile in a start-up to what they typically would command in the open market is the tipping point between an average and a high performing management team.
(3) Risks & Returns: SPACs may be asset-less at the time of listing, but they do have a business plan that is as detailed and robust as that of any IPO. Each SPAC business plan, model and strategy is very different.
Because of market pressure to execute a QA quickly after listing, SPACs have often failed at the point of making their QA because they either rushed the due diligence process or bought a QA that was in a sector that was outside of the management’s expertise. After eliminating the common denominators in IPO listings, a 2007 Washington University Law Review article pointed out that because of their structure, SPACs actually help reduce downside risks by providing increased investor control over expenditure and approval of QAs proposed by the management. Shareholders need to understand the SPAC strategy and realise that selecting the right asset that fits the SPAC strategy may take additional time to ensure that quality assets are delivered and shareholder value is not eroded.
In terms of returns, the article also noted that in the US, “SPACs that successfully conduct an acquisition offer investors the potential for extraordinary profits.” It stated that the average return of SPACs that completed a business combination between September 2003 and March 2006 was nearly forty per cent.
So, can SPACs offer investors a higher payout upon completing a successful QA and forging a sustainable business model? Absolutely, but understanding and judging the management team’s experience, track record and ability to execute its acquisition and growth strategy is key to investing in SPACs.
There are rewards and risks associated in any capital markets trade. It is the responsibility of the SPAC Management Team and regulators to present all the factors clearly so investors can make their own informed decision.
Note: The above commentary is not a recommendation to buy or sell. Please consult your stockbroker and/or financial adviser before making any investment decision.
Gan Kim Khoon is Director and Regional Head (Equity Capital Markets), Corporate & Investment Banking Services at RHB Investment Bank Berhad.