On Wall Street, strange financial products sometimes exist not because they are good for investors or companies, but because they offer their promoters a way to profit.
One of those products may be the Silver Eagle Acquisition Company, which just completed a $325 million initial public offering.
Silver Eagle is a special purpose acquisition company, or SPAC, which raises money through an I.P.O. and then casts a wide net in search of a private company to buy. Silver Eagle’s I.P.O. is the largest in the past seven years for a SPAC and sure to earn its promoters millions, but the outcome is not so clear for its investors or even the company itself.
A SPAC, also known as a blank check company, has been referred to as the poor man’s private equity because the promoters of the SPAC get up to 20 percent of the equity mostly for finding the target company. The fee is similar to that of a private equity firm, as is the idea of picking a company, but a SPAC is not as safe or rewarding as private equity. SPAC investors take all of the risk in one company instead of a portfolio of companies held by a private equity firm. And unlike a private equity firm, which hires the best and the brightest, there have been an assortment of SPAC promoters with varying expertise. Lou Holtz, the former football coach of Notre Dame, was part of one, as was former Vice President Dan Quayle. Even Stephen Wozniak, a founder of Apple Computer, was involved in one.
In the 1980s, they were rife with fraud, and briefly disappeared from Wall Street in the wake of stricter federal regulation. But, like zombies, they reappeared in the mid-2000s. Before the credit crisis, these vehicles accounted for nearly 25 percent of all I.P.O.’s. They are less scandalous, but they still have problems. The biggest peril may be that while a SPAC is formed to acquire a company, the target is unknown at the time of the I.P.O. The SPAC has a period â€" nowadays up to two years â€" to complete an acquisition or liquidate.
Two years may seem a long time, but time runs quickly in finance, and the promoters are often rushed to complete an acquisition.
That means the promoters can make bad choices. According to SPAC Analytics, of the 198 SPACs since 2004, 72 have liquidated, earning almost no returns for their investors. Even so, liquidation may be the better option. Of the 111 SPACs that acquired companies, their average return, according to SPAC Analytics, was minus 14.4 percent. By contrast, the Russell 3000-stock index in that same period had a positive return of 5.9 percent.
It’s not just that the returns are terrible. There have been some spectacular failures as SPACs have rushed into hot markets like energy, China and even water.
The worst was probably Chardan 2008 China Acquisition Corporation, formed to acquire a Chinese company. With its clock ticking, Chardan changed course and decided to enter another hot field, the Florida foreclosure market. Chardan acquired the foreclosure processing operations of the lawyer David J. Stern. Unfortunately, Chardan’s due diligence was less than stellar, and the firm got caught in the fraudulent paperwork scandal, better known as robo-signing. Chardan imploded in bankruptcy.
Another high-profile SPAC, Endeavor Acquisition, completed its $385 million purchase of 41 percent of American Apparel only three days before it was due to liquidate. Before American Apparel, Endeavor had considered buying a “branded restaurant chain with franchising opportunities,†and then a weight-loss company. Instead, T-shirts awaited, but it was a foolhardy purchase, and American Apparel is now trading around $2 a share with a market capitalization of about $214 million.
Then there is Heckmann Corporation, a SPAC that acquired the fifth-largest Chinese water bottler for $625 million in 2008. It seemed a winning proposition, combining water and billions of Chinese consumers. Heckmann renamed itself Nuveera. But it sold the business for almost nothing to a Hong Kong buyer in 2011. Heckmann, by the way, was the SPAC that Mr. Holtz and Mr. Quayle were involved in. (Mr. Wozniak’s SPAC was also a dud. It raised $150 million and acquired Jazz Semiconductor in 2006 for $260 million. Jazz was later sold for $40 million.)
SPACs have brought companies to market that do not appear to perform particularly well. There have been some successes, including Burger King, which went public through a London-based SPAC, but the failures appear to far outnumber the successes.
But Silver Eagle’s I.P.O. shows that these entities are thriving despite the record of failure. Silver Eagle is the fourth SPAC to go public this year.
Silver Eagle was formed by Harry E. Sloan, the former chief executive of Metro-Goldwyn-Mayer Studios, and Jeff Sagansky, the former president of CBS Entertainment. Silver Eagle will look to acquire a “media or entertainment businesses with high growth potential in the United States or internationally.â€
Maybe. Silver Eagle still has many traits that have brought SPACs trouble.
Silver Eagle will have the two years to make an acquisition, but as the prospectus discloses, the promoters can also seek to acquire any other type of company.
The promoters are also experienced executives in the entertainment industry but not in private equity. Mr. Sloan and Mr. Sagansky’s first SPAC, Global Eagle, acquired Row 44 and Advanced Inflight Alliance in January. So far, it is up about 6 percent from the $10 a share I.P.O. price. That is no spectacular return.
Not only that, Silver Eagle has taken advantage of the JOBS Act to limit the disclosures made by the company. This loophole has been criticized for repeatedly being used by SPACs instead of the emerging growth companies it was intended for.
You’re probably wondering how Mr. Sloan and Mr. Sagansky could raise so much money. It is here that the magic of finance takes over.
A number of hedge funds are big buyers of SPAC shares. The reason, paradoxically, is the protections that SPACs have put in place over the years to protect shareholders.
To make sure that SPACs acquire an appropriate company, they have a feature that allows shareholders to redeem their shares if they do not approve of the acquisition. Prior iterations of SPACs also required a shareholder vote of 80 percent to approve the acquisition.
Intended to protect shareholders, the feature has provided hedge funds a nice investment payoff. The funds can buy I.P.O. shares at, say, $10 a share and then redeem them for the same price if they do not like the acquisition, giving them a safe place to hold cash. Alternatively, the funds have a nice potential upside if the stock price rises when the acquisition is announced.
The SPAC was thus a win-win for the funds and led them to actively invest, sometimes using their power of redemption or the vote to hold up the promoters and get better terms.
SPACs, then, are good for promoters and hedge funds. But the real question is whether they are good for the acquired companies.
After the acquisition, the companies often appear to perform poorly. The returns certainly show this. The stumbles of American Apparel and other SPAC acquisitions also show that these companies are sometimes being brought to market before they are ready.
In other words, SPACs may persist, not because they are good for investors or the companies themselves, but because they are a sought-after financial product. This may also be true for Silver Eagle, but for its sake, let’s hope that past performance is no indication of future results.
