Deals Seeking Purpose

Special purpose acquisition corporations have caught on in recent years. Could this quirky investment vehicle have broader use in M&A?
IN THE PAST TWO YEARS, a new corporate finance structure — the special purpose acquisition corporation (SPAC) — has emerged to great fanfare in Canada. SPACs have the potential to fill a gap in the Canadian capital markets, facilitating acquisitions of private companies in the $100- to $500-million range.

SPACs offer qualified acquirees an easier way (than a traditional initial public offering) to tap public capital markets. “It may be a more attractive opportunity than doing an IPO because the financing is already available and the legwork has been done, and there’s a good management team they can hook into,” says Ava Yaskiel, Global Head of Corporate, M&A and Securities at Norton Rose Fulbright Canada LLP.

SPACs give retail investors, who would not be able to buy into hedge funds or private-equity funds, the chance to participate in the acquisition of private operating companies that might otherwise be targets for those funds. The structure also gives investors a leveraged opportunity to participate in the upside through warrants.

The primary purpose of a SPAC — a publicly traded shell company — is to acquire one or more private operating companies. SPACs raise money through an IPO. Participants include not only pension funds and retail investors but often hedge funds and private-equity funds. At least 90 per cent of the capital raised by the IPO must be placed in an escrow account and then used towards the qualifying acquisition. Canada has had six SPACs do IPOs to date, raising over $1 billion.

A SPAC is founded by a sponsor (or founder) with the credibility and know-how to raise capital and identify a promising operating business. The founder (together, if desired, with some or all of the directors or officers of the SPAC) holds 100-per-cent ownership of the SPAC before its IPO and assembles its management team.

Once listed on the TSX, a SPAC has up to 36 months to complete a qualifying acquisition, though market practice has dictated a period of 21 to 24 months. The SPAC-specific listing requirements imposed by the TSX include a minimum offering price of $2 a share and at least 1,000,000 freely tradeable shares with an aggregate market value of at least $30 million.

The SPAC is not allowed to have a binding agreement with a target company before it does its IPO. The SPAC prospectus typically states that it hasn’t identified a qualifying acquisition target and has not initiated substantive discussion with any potential acquisition target.

The TSX adopted its listing rules for SPACs back in 2008 in order to imitate NASDAQ and the NYSE, but Canadian investors sat on the sidelines until 2015.

“The TSX brought in its rules at a most inopportune time, because the capital markets were in a poor state following the 2008 credit crisis,” says Stephen Pincus, a partner at Goodmans LLP in Toronto. “In fact, you couldn’t have picked a worse time for the rules to come in. People weren’t ready for something new.”

IPOs generally were very slow during this intervening period and the TSX rules for SPACs were not user-friendly, says Yaskiel. “It took someone jumping into the water to test the market.”

That someone was Dundee Acquisition Corp., which raised $112 million in an IPO in April 2015. Simon Romano, a partner at Stikeman Elliott LLP, says it took about a year of negotiating with the TSX and the Ontario Securities Commission to allow Dundee’s SPAC, “and we got a number of exemptions from their rules.”

“That opened the floodgates,” says Romano. “The TSX has granted the same exemptions six times. Once those exemptions were in place, the concept of a US-style SPAC became much more doable. They’re still a bit more restrictive here, but not too bad now.”

Even with several SPACs having done IPOs, “the jury was really out until last fall on whether it was going to be a success,” Yasiel says. Doug Marshall, a partner at Osler, Hoskin & Harcourt LLP, thinks the jury is still out. “I don’t see any real momentum for the structure,” he says. “There haven’t been any others since the first wave of them, and that’s because people are trying to assess whether they’ll actually get transactions completed.”

INFOR Acquisition Corp., which raised $230 million in its IPO, was the first SPAC to try a transaction — it would have been acquired by ECN Capital — but the deal collapsed last October due to shareholder opposition. Dundee announced in January that so many investors were redeeming their stock that it didn’t have enough cash to finance its acquisition of CHC Student Housing Corp. The deal is currently on hold.

Until the qualifying acquisition, the SPAC is a very safe investment, because the funds in escrow must be invested in treasury bills, and shareholders (other than sponsors) have the right to redeem their shares until the acquisition closes. (The qualifying acquisition must be approved by a majority vote of the shareholders.)

Each share comes with a warrant. If the SPAC appreciates in secondary-market trading following the qualifying acquisition, the warrant holder has the benefit of being able to buy additional shares at the fixed price, or exercise price, before the warrant’s expiry date.

For the investor, says Pincus, “it’s heads, I win; tails, I don’t lose. Because if I redeem, I’ve got my money back, and still I’ve got this warrant. And if the SPAC does very well, this warrant has value in it. The warrant and the shares are separable.”

Although originally conceived of as a private-equity play for the retail investor, a SPAC IPO tends to attract hedge-fund interest due to the detachable warrants. The hedge funds intend to redeem their shares while hoping, says Marshall, that “enough shareholders stay in so that the transaction goes forward, and then the warrants come into the money. It’s an infinite return, because it’s a zero investment. It’s perfectly hedged.”

Whereas the initial SPACs in Canada were generic, the more recent ones have aimed at specific sectors and geographic areas. For example, Gibraltar Growth Corp. targets North American consumer businesses, Avingstone Acquisition Corp. focuses on hospitality and related real estate opportunities in the Americas and Europe, while Kew Media Group Inc. concentrates on international media production and distribution businesses, with an emphasis on Canada, the United States and the United Kingdom.

Retail investors can derive comfort from this shift toward sector-specific SPACs, says Yaskiel. The investor thinks, “It’s a space I might be interested in investing in. I don’t know the specifics of the target, but at least I know the sponsors or founders have familiarity with that space, so I have confidence they’ll find the right thing, as they’ve been successful in the past.”

Acasta Enterprises Inc. has been the largest SPAC in Canada to date, raising $450 million and doing three acquisitions simultaneously with an enterprise value of $1.2 billion. Alignvest Acquisition Corp. raised about $259 million and did one transaction. “That might give impetus, as the success of those [acquisitions] is monitored, for more players to get into the market,” says Yaskiel.

Having been involved in the first six SPACs in Canada — on behalf of either the issuer or the underwriter — Romano says the ideal SPAC IPO for the Canadian market is $150 to $250 million. This facilitates a qualifying acquisition with a market value at least two or three times that amount.

Typically, the transactions are a combination of cash and shares of the SPAC, says Pincus. “And typically also, the SPAC will go out and raise more cash at the time of the acquisition through a private placement of additional shares. They can also borrow money from a bank.”

The “blank cheque” nature of the process carries the risk that, when investors learn what the target acquisition is, those who are dissatisfied will redeem their shares, creating a shortfall in the financing. When Alignvest announced its transaction, for instance, 23 per cent of its Class A shareholders redeemed their shares. However, this was more than offset by $82 million committed upfront through private placements. “It’s the best example we’ve seen so far of the risk of redemptions being mitigated,” says Romano. “Other folks are announcing their transactions and trying to find money while in the process of selling it to their shareholders.”

Yaskiel, however, points out that the only way to practically mitigate the potential of redemptions sabotaging the qualifying acquisition “is to make sure you’ve chosen a target that you think you can sell to the investors. Otherwise ... you better be prepared to put up more of your own money, founders and sponsors, to fill any gap that is caused by redemptions.”

Pincus, who was involved in three of the first six SPACs, says the structure has a promising future in Canada, because it can serve more than one purpose. Yes, it can be a tool to do a reverse takeover and take a private company public, after which the sponsors move on. But he cites Acasta’s “roll up” transaction — the first time globally where a SPAC has bought three companies.

After the deal closed in January, Acasta announced it would become a private-equity manager, seeking to invest in sectors such as infrastructure, energy and high-end manufacturing. “A SPAC is a powerful tool if it’s structured well, and if it has a strong management team behind it,” Pincus says.