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Blank cheque IPOs are back

So in 2021, would you invest in a company set up to buy an undertaking at great advantage, but nobody to know what it is? That is essentially the investing proposition of Spacs (Special Purpose Acquisition Vehicles), and on some reckonings, 405 have together raised $125bn in the US since the beginning of last year. Here’s how they work:

1.   A sponsor invites investors to subscribe for units, consisting of shares and warrants, in a shell company. The warrants are effectively market-priced options and so leveraged on the share price. Monies raised by the sponsor are held in trust and invested in six-month Treasury Bills.

2.   The sponsor hunts for an attractive target company, and is given two years to bag it at a reasonable valuation. It funds the costs of setting up the Spac, and in return is allocated shares and warrants. These could be worth about a fifth of the company when the acquisition is completed.

3.   Once a target has been bagged, investors are asked to approve the acquisition. Those voting in favour receive similar shares and warrants to the sponsor. But most investors vote for the transaction but against continuing with the Spac. That way, they surrender their shares for what they paid for them, but can keep the warrants.

4.   With so much being returned to the Spac investors, the combined company then needs to raise more funds. This permanent capital is raised from the public, but with skimpier disclosure than a traditional initial public offering (IPO) requires.

This structure has turned the risk on its head. Hedge funds and others investing in a Spac regard it as a no-brainer: you can get your money back with the warrants thrown in for free. With the right deal, the share price of the acquired company soars, as happened with Clarivate Analytics (US:CLVT) in 2019 and DraftKings (US:DKNG) in 2020, where the warrants proved to be hugely lucrative. With the surge in Spacs hunting for target companies, more sellers have come forward. Many are speculative tech companies of varying quality, and valuations are discounting heroic growth assumptions, reminiscent of the TMT boom at the turn of the century. Many are still developing their product. Reports suggest that nine auto groups had a combined $60bn Spac listing last year even though they only generated $139m of revenues in 2020. In February this year, Lucid Motors (US: , due to launch its first electric car, went public in a $24bn deal. It hopes to rival Tesla (US:TSLA).

The last time Spacs were so prominent was in the run up to the 2008 financial crash. The current bubble is driven by the prospective profits for the Spac investors, sponsors and financiers, and it’s likely to be sustained as long as interest rates stay low. For the targets, the speed and cost of coming to market beats an IPO, and founders can sell more of their holdings quicker - Spacs don’t have the lock-in period that IPOs usually have. US Spacs seem to be looking for targets elsewhere, possibly with partners on Euronext Amsterdam, where, unlike the UK, the listing rules facilitate the financing of Spacs.

Not only has UK lost trade to Amsterdam after Brexit, but there are good reasons why the US Spac model has not been replicated here. One is that US multiples are higher. Another is trust: money raised in the UK need not be placed in a Trust, and in reverse takeovers, as in a Spac, a shareholder vote is not deemed necessary. Nor is there a requirement to return funds to dissenting shareholders. The acquisition process needs to be seamless: suspending shares during transactions, and cancelling the listing pending a prospectus for the acquired group are major obstructions.

Lord Hill’s review of the UK Listing Rules was supposed to beef up the UK’s attractiveness as a global financial centre, and encouraging Spacs was part of this. Removing the need for a prospectus shifts more risk onto those funding the permanent capital – it enables more marginal propositions to be hyped to the public with more limited disclosure than was previously required. Mr MacKay’s concluding words about the notorious company of 300 years ago illustrated one consequence of too little investor protection: “At nine o’clock, this great man opened an office in Cornhill… and raised £2,000 [equivalent to £4m today] in just five hours. He was philosopher enough to be contented with his venture, and set off the same evening for the Continent. He was never heard of again.”