SPACs & the Red Sycamore Position

There is a lot of talk about Special Purpose Acquisition Companies (SPAC).  A SPAC is a company with no commercial operations, a vehicle formed specifically to raise capital through an initial public offering (IPO), for the purpose of acquiring an existing company.  They are known as blank check companies, although I quite dislike this characterisation.  SPACs have been around for decades, but they have become more popular in recent years due to high-profile deals in the US. 

SPACs are formed by initial investors, called sponsors, with expertise in a particular industry, business sector or region.  The intention is to use the SPAC as a vehicle to pursuing deals in that area.  SPAC founders generally have acquisition targets in mind, but this is never disclosed to prevent another entity from buying up equity in the target to raise to price, and to avoid the need for extensive disclosures during the IPO process.  This is why they are called “blank check companies”, since IPO investors have no idea what company they ultimately will be investing in.  SPACs appoint underwriters and court institutional investors before offering shares to the public.  The investors in SPACs can range from major private equity funds to retail investors. 

At the time of their IPOs, SPACs have no existing business operations.  As such, the money SPACs raise in an IPO are placed in an interest-bearing trust account.  These funds cannot be disbursed except to complete an acquisition or to return the money to investors, in the event the SPAC is liquidated.  SPACs have two years to complete an acquisition or they must return their funds to investors.  In some cases, some of the interest earned from the trust can be used as the SPAC’s working capital.  After an acquisition, a SPAC is usually listed on one of the major stock exchanges. 

Being acquired by a SPAC is an attractive option for owners of a smaller company, or for a company seeking a quick listing to raise further funds in the market.  Selling to a SPAC adds up to 20% to the sale price compared to a typical private equity deal.  A SPAC acquisition is a short cut to IPO for companies that do not have the three year track record.  SPACs often have experienced partners, with access to further funding, who can navigate the IPO process. 

SPACs have experienced a resurgence in popularity in recent years, attracting major underwriters such as Goldman Sachs, Credit Suisse, and others.  Retired and semi-retired executives helm them looking for a relatively quick payday from a short project.  Which brings us to the Singapore Exchange (SGX).  SGX has observed, with interest, the popularity of SPACs listings in other markets.  This has sparked renewed interest for SPACs to be introduced to the Singapore capital market.  SGX suffers from a chronically under-developed secondary market, and SPACs could help that as well.  Accordingly, SGX launched a public consultation exercise, which was open until the 28^th April 2021, to assess the appetite for SPACs and consider allowing them to list.  Depending on the feedback from the consultation, SGX are aiming to introduce a framework by mid-2021. 

This is a welcome development.  We need to develop more Asian-based SPACs to add depth to the market and spur the secondary market.  SPACs would also help the market move into a new direction.  Currently, the SGX is dominated by banks and real estate.  We lack technology, pharmaceutical and other stocks, which is a strategic concern if we want to reposition the economy for a post-climate change environment.  Aside from raising the capital help in the market, it would also encourage some variety in future listings. 

Another possible advantage for SPACs would be to increase investor choice.  It is as a result of the variety of growth industries that SPACs tend to focus on. When they list, investors are afforded an opportunity to be exposed to these high-growth companies early.  Otherwise, they would be priced out of the IPO, and would have to pick them up at higher prices in the secondary market, which is a deterrent.  Singapore retail investors are not particularly sophisticated.  They tend to be conservative, and move in a herd mentality.  They are coddled, and lack discernment.  They have substantial disposable income.  This would be an educational opportunity for them. 

Currently, in the consultation paper, SGX has proposed that Singapore SPACs have a minimum market capitalisation of S$300 million, aligned with mainboard rules, with a timeframe of three years to de-SPAC.  This ensures that SPACs formed have the financial muscle to actually engage in a buyout of a target business.  The larger sum also ensures that any SPAC formed has experienced sponsors and management, with access to further resources, and have a track record.  This is to protect retail investors.  They propose that a minimum 90% of IPO proceeds to be placed in escrow pending acquisition of a target.  This ensures that funds are not squandered in management remuneration.  The three year time-frame limits to adverse effect on opportunity cost should the SPAC disband. 

To further protect independent and retail shareholders from adverse sponsors and management interests, and ensure that they are all aligned, SGX has proposed that sponsors and management, as well as their associates, are restricted from voting on business combinations.  This means business combination transactions are completed on terms which are not prejudicial to the interests of the SPAC and independent shareholders.  Approval of the business combination must be obtained from the SPAC’s independent directors and independent shareholders. 

Independent shareholders who vote against the business combination may choose to redeem their ordinary shares for a pro rata amount of cash held in escrow.  SGX also proposed imposing a moratorium on shareholding interests of key parties at specified junctures, and subject founding shareholders and management team to a minimum equity participation.  This will be determined based on the market capitalisation size of the SPAC at IPO. 

To safeguard against dilution risks, SGX proposed limiting capital redemption rights at de-SPAC to independent shareholders who vote against the business combination.  The redeemed shares are to be cancelled, and accompanying warrants are to be nullified and void.  This restriction may mitigate concerns on high redemption rates at the vote for the business combination.  This is because due to additional funding requirements to complete the business combination, it would cause further dilution to remaining shareholders.  To further mitigate dilution risks arising after the business combination, SGX proposed for any warrants to be linked to underlying ordinary shares so that they are nullified when a share is redeemed. 

The biggest hurdle for any SPAC in Singapore is the proposal that upon successful completion of business combinations, SGX proposed resulting issuers meet some existing listing requirements, such as requiring “prospectus-level disclosures” on the target businesses, and shareholders’ circulars containing information such as the financial position and company management to be submitted to SGX for review.  Resulting issuers that do not meet listing requirements under mainboard rules will be delisted.  This requires further though on the disclosure of target business.  This would put a timeline pressure on SPAC management to complete the deal quickly. 

All that aside, however, with strong demand in the region, and clamour for Asian-sponsored SPACs that have listed in other exchanges, the prospects of having SPACs in Singapore are very positive, and it is likely that we will see them here.  Singapore is well placed to become an Asian hub for SPACs, complementary to the recent introduction of VCCs, and proliferation of SFOs.  The environment is ripe for a new asset class. 

Some would claim that the declining IPOs of SPACs, particularly in the United States, point to a conclusion that Asian markets missed out, but we must also consider that in the fort quarter of 2021, amidst a pandemic, SPACs have already raised more than US$100 billion globally.  The vast majority of listings are on American exchanges.  SPACs are here to stay, but there will be a period of consolidation, and a tightening of regulations in Asia, where authorities are more risk-averse, and for good reason. 

There is an element of bandwagonism in the US, and SPACs differ in quality, and size.  It would makes sense to learn from the American experience, and only take the best.  This is the purpose of that SGX public consultation.  Whilst it can be argued that this conservative approach to SPACs will severely impact the number of deals, it raises the quality of SPACs on offer, and the viability of remaining deals.  American regulators have already indicated that they are clamping down on some aspects of SPACs, including the dilution risks of untethered warrants. 

Major banks have issued reports estimating that SPACS have around US$129 billion of capital requiring deployment in the next few years.  That alone is expected to create as much as US$900 billion in enterprise value via mergers and acquisitions over the next 24 months, assuming they work.  In the meantime, there is a lot of capital locked up in lower yield asset classes which could be better deployed elsewhere.  There is a danger of a bubble there, if the quality of the deals is not as expected. 

As much as we want Singapore to be a SPAC hub in Asia, we must also be wary of having too much capital locked up due to unreasonably optimistic assumptions, only to de-SPAC.  If these companies do not meet listing requirements, that backdoor route to listing is closed, and value creation is loss.  We cannot afford to absorb that amount of opportunity cost. 

There is increasing concern among regulators and investors about the rosy projections some emerging technology companies have made ahead of their SPAC mergers with SPACs.  Most of them are in the electric vehicle space.  As it is, Nikola Corporation, which has not produced a single viable battery or vehicle, is still valued at US$5 billion.  Faraday Future, a seven-year-old electric vehicle (EV) start-up, has yet to sell a single car or even develop a viable battery.  It is still projecting more than 266,000 vehicles in sales and US$21.4 billion in revenue by 2025, according to its investor presentation.  The company, founded by failed Chinese tycoon Jia Yue Ting, agreed to go public via a SPAC in January 2021. 

Considering these concerns, although we have fielded enquiries directly, or through our partner entities, we are not ready to take the first SPAC deal that falls on the table.  The numbers have to be right, and we must still maintain control of the company’s direction.  We have an EV that is ready for production.  We have a battery that is proven to be superior to any in the market.  What we want is market dominance, not a quick IPO.  A SPAC is worth considering, but only on our terms.