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Saturday, Jan 28, 2023

SPAC Attack: Investment Vehicles See Surge in Popularity

Special purpose acquisition companies, or SPACs, are in the midst of their biggest moment yet.

Driven in part by successful deals at local firms like the Gores Group and Harry Sloan’s series of Eagle SPACs, a host of major companies and investors are taking up the approach. 

SPACs accounted for fully 35% of U.S. initial public offerings through June 2020, according to Silicon Valley Bank. Combined, the vehicles raised $19 billion in the first six months of this year — more than the total raised in the six years from 2010 through 2016. 

Among those deals were a series of headline- grabbing local moves, such as Draftkings Inc.’s $3.3 billion merger with Diamond Eagle Acquisition Corp. and planned multibillion-dollar SPAC mergers for electric-vehicle makers Canoo Inc. and Fisker Inc.

The growth in SPACs’ popularity has only accelerated as the Covid-19 pandemic has worn on, prompting some industry observers to wonder whether this is the beginning of a new paradigm in the public markets — or a SPAC bubble waiting to pop.
In from the cold

Also known as blank-check companies, SPACs are business entities that have no operations of their own. They are created to raise funds through initial public offerings. Managers then use the funded vehicle to acquire a target business looking to go public in a reverse merger.

SPACs have recently become known as a way to raise public funding more quickly than through a traditional IPO, particularly for high-growth, capital-
intensive companies. One of their key advantages is that they often have lower levels of near-term uncertainty since most funding is already locked in place before the target company becomes public.

Blank-check companies didn’t always have such a rosy reputation, however.

A decade ago, they were often thought of as a way for companies with less-than-compelling investment prospects to sneak around the IPO process. 

“In the early days, SPACs had a bad name,” said Sloan, former chief executive of MGM Holdings Inc. and founder of six Century City-based SPACs under the Eagle name — including Diamond Eagle Acquisition Corp. 

“You never wanted too much publicity as a SPAC guy when we started this in 2011,” Sloan said.

Sloan said that he and his partner, former CBS Entertainment Group Chief Executive Jeff Sagansky, had to lean heavily on their own reputations and industry expertise to win over investors early on. 

“What we said was, ‘We are media guys. We are going to bring you what we know,’” Sloan said. “If something went wrong with the leadership of the company, we could temporarily step in as media executives.”

“I don’t think people would have invested with us without our expertise,” he added.

Most of Sloan’s SPAC deals have targeted companies with at least some tie-in to the media and entertainment space. His latest play, a $3.5 billion merger between his Flying Eagle Acquisition Corp. SPAC and mobile gaming platform Skillz Inc., is a bet on esports as a future pillar of the entertainment industry. 

In the past, many SPACs followed a similar model of relying on their sponsors’ sector expertise to draw in investors, albeit usually with less success than Sloan’s endeavors. 

Three years after Sloan raised his first SPAC, another group of local dealmakers was looking to redefine that decades-old approach.

Mark Stone of Beverly Hills private equity firm Gores Group said he and the firm’s founder, Alec Gores, had started exploring SPACs as a potential way to expand beyond traditional private equity offerings.  

“SPACs didn’t have a good reputation (at that time),” Stone said. “We decided that the vehicle wasn’t flawed but that people hadn’t executed appropriately for it. … We thought we could do it right.”

Stone, who now leads Gores’ SPAC practice, said the relatively small size of most older SPAC investment pools meant the vehicles could often only target companies below investment grade. 

“We said, ‘Let’s turn this on its head, let’s go after $2 billion-plus (enterprise value) companies — what we call mid-market,” Stone said.

Rather than relying on personal industry knowledge, Stone’s strategy was to bring large capital pools that would attract companies with strong growth trajectories. His firm would add additional investors through private investments in public equity, or PIPEs, both boosting the total capital available and bolstering investor confidence by adding leading institutional players to the deals.

Over the ensuing five years, Stone led six SPAC raises for Gores under this model. Four of those blank-check companies have completed mergers to date, with targets ranging from iconic snack maker Hostess Brands Inc., to autonomous vehicle sensor maker Luminar Technologies Inc. 

The success of these deals has led Gores Group to increasingly focus on SPACs in recent years, although Stone said the company also remains committed to its traditional private equity business.
Fever pitch

The participation of players like Gores Group in the SPAC space had effects beyond shifts in the individual firms’ strategies. As SPAC sponsors increasingly became known as established and reputable market participants, blank-check companies began to shed their longstanding dubious reputations.

“It certainly has helped improve the image of the SPACs,” said Paul Sachs, a managing director at consulting firm Protiviti Inc. 

Sachs said the combination of these firms’ strong reputations and the ability to raise larger capital pools was likely key to the sea change surrounding SPACs.

“In a traditional SPAC, the sponsor is going to have a board seat,” Sachs said. “If a company is going to give that up as part of going public, they have to make sure that is someone they would want to be working with in the long term.”

This improving reputation laid the groundwork for what Sachs called the “perfect storm” for SPACs to take off once the Covid-19 pandemic hit.

“The economic volatility and distinct price decline have made IPOs and direct listings impractical options for many private companies,” Sachs said. “That has certainly brought the spotlight to SPACs as a way for private companies to gain access to public markets.”

From an investor standpoint, many private equity firms, hedge funds and other asset managers were sitting on huge pools of capital at the start of this year. Sachs said SPACs emerged as one of the most viable ways for these firms to invest their funds quickly and take advantage of the strong equity markets in recent months. 

“The SPACs have certainly benefited from the pandemic,” Sachs said. “That’s part of why we have seen the increasing number of SPACs coming up, as well as why some big institutional players are getting into it.”
Mainstream alternative?

Predictions on where the current
 flurry of market activity eventually leads for the SPAC sector range from bullish to bearish. 

“What happens through the end of the year, particularly with all the uncertainty with the macro environment, will determine the future of SPACs,” said Robby Kumar, a Santa Monica-based managing director at Silicon Valley Bank. “It goes back to the performance of this cohort (of SPACs), which is so different from past groups.”

Kumar’s bank is bullish on SPACs and included in its third-quarter “State of the Markets” report this prediction: “If SPACs and direct listings continue to gain adoption, the traditional IPO route could eventually become antiquated.”

Kumar said he thinks such a dramatic shift is unlikely, but added that SPACs could become a mainstream alternative to IPOs if the current group of deals pans out well for businesses and investors.

Gores Group’s Stone is somewhat less confident that the current trajectory of the SPAC market is sustainable. “I think there is a danger of the SPAC market getting oversaturated,” he said. “It won’t surprise me if there is a lot of carnage.”

Stone said he sees SPACs as a strong alternative to traditional IPOs now and in the future, but only for the companies whose individual situations are truly suited to the approach.

“We had a company that we were talking to that we wanted to take public recently,” Stone said. “Obviously, I wanted them to go with us because I wanted to do the deal, but they ended up deciding that an IPO fit their goals better.”

“I sat down with Alec (Gores) after, and I said, ‘You know, honestly, if I were them, I would have made the same choice,’” he said. “The IPO was more appropriate for their goals.”

Keep reading the Banking & Finance Quarterly Report.


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