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Why traditional IPOs are being shunted by SPACS

While the world’s financial markets are looking increasingly volatile, progressive investors interested in safe, secure financial vehicles are turning in droves to a revived form of investments: Special Purpose Acquisition Companies (SPACs)

After a great deal of success in the domestic US market and limited success on the London Stock Exchange and some major European bourses, we predict that NYSE/NASDAQ listed SPACs will begin to make an increased number of acquisitions of privately held companies in emerging markets.

There are three factors that make SPACs, as an investment option, attractive:

  1. They give the public access to private equity investments, an area that previously was only available to institutional clients like hedge funds and investment banks.

  2. SPACs have greater transparency than private equity investments, as indicated by SEC reporting requirements like the filing of financial statements and by the voting rights of shareholders in regard to mergers or acquisitions.

  3. SPACs have a limited downside to investors as they hold the proceeds of the IPO in trust. If an acquisition is not made within 18 to 24 months, the amount held in trust is returned

SPACs can be viewed as a form of a reverse merger with lower risks. These benchmarks combine to make SPACs relatively attractive.

The investment industry is growing in its openness with clients and potential and is now willing to adopt creative partnerships. The trade-off? Disrupting the traditional private equity model, while harnessing greater flexibility for everyone involved.

SPACs will become more prevalent and assist in making new sources of funding available.

Given the usual lock-up period of five to seven years in private equity funds, SPACs offer an exciting and fast paced alternative to Founder Shareholders who will usually have a maximum lock up of thirty-six months, between the time of the IPO of the SPAC itself, and the mandatory wait for one year after the business combination has taken place and the resulting entity has been listed on the stock market.

According to The Hedge Fund Journal, as of March 2008, there were 67 SPACs registered with the SEC.

By August 2013, Axial  was projecting over $2 billion raised through SPACs for the first time since 2005. 

In 2018, SPACs had their best year ever in terms of deal value and their highest volume since 2007, with 46 initial public offerings (IPOs) raising nearly $10 billion. This number is projected to rise in 2019, with 15 SPACs raising $3 billion in Q1 alone.

Due to this, at the beginning of 2019, Severnaya Investments created the world’s first fully dedicated SPAC consultancy division, Severnaya SPACs, to focus on raising money on the two major US stock Exchanges, with a view to acquisitions in key emerging markets in Eastern Europe, the Middle East, South East Asia and Latin America.

“SPACs provide great opportunities for private companies to go public, without all the usual complications of running their own IPO. At the same time, this allows for the top management of the company that is in the process of being acquired to concentrate on their business, while the board and management of the SPAC are running the due diligence,” said Sergey Mizenin, Managing Director of Severnaya Investments.

“Our expertise in emerging markets shows that a considerable number of companies in the TMT space in those markets are ripe for acquisition by US listed SPACs,” he added.

Wherever a company is based, management and owners place special emphasis on stock markets that value businesses, while maintaining a fairly based success rate.

These higher quality businesses want to avoid capital markets that lack success and transparency.

“We believe we can provide a fair platform for high quality businesses, independent of their geographical location. We are happy to speak with anyone who has the same interests,” Mizenin added.

How does a SPAC work?

According to a Harvard report, written by Ramey Layne and Brenda Lenaham, partners at Vinson & Elkins LLP, Special Purpose Acquisition Companies are entities which create capital through an initial public offering with the intention of using the yield to acquire one or more undetermined businesses or holdings to be ascertained after the IPO.

A SPAC goes through the normal IPO process, which means a registration affirmation, or “statement,” is filed with the U.S. Securities and Exchange Commission, or SEC. The funds from the IPO are held in trust until released to fund the business merger/combination or used to buy-back shares sold in the IPO.

How do SPAC warrants work?

The purchase price per unit of the securities is normally $10.00. Warrants can be exchanged in the public market, with the warrant’s purpose being to furnish investors with further indemnities for investing in the SPAC.

As reported by SeekingAlpha, when a SPAC floats an IPO to raise the required capital to complete an acquisition, each investor can own units in exchange for capital. Each unit constitutes a share of common stock and a warrant to acquire common stock at a later date.

Investors who aren't averse to risk can find opportunities in SPAC warrants, usually carrying a five-year term after any merger has been completed.

SPAC warrants are a binary proposition of a five-year warrant on a hypothetical future company. 

Any downside is protected by the fact that ordinary shareholders can redeem their common shares for cash at any time .

The upside comes from the performance of the warrants included in SPAC units from the IPO.

When an actual acquisition target is presented, and the deal appears to be headed toward closing, warrant valuations tend to increase, often dramatically in some cases.

What are blank check companies?

blank check company is a developing stage company that has no specific business plan or purpose or has signalled that its business plan is to enlist a merger or acquisition with an unnamed company or companies, other entity, or person.

What happens when a private company merges with a public "blank check" company?

Unlike reverse mergers, SPACs come with a clean public shell company, better economics for the management teams and sponsors, certainty of financing/growth capital in place - a built-in institutional investor base and an experienced management team.

SPACs are set up with a clean sheet where the management team searches for a target to acquire. There are no pre-existing companies as in reverse mergers.

SPACs also raise more money than reverse mergers at the time of their IPO. The average SPAC IPO in 2018 raised approximately $234 million compared to $5.24 million raised through reverse mergers in the months immediately preceding and following the completion of their IPOs. 

The reason hedge funds and investment banks are interested in SPACs is because the risk factors are lower than in reverse mergers.

Virgin Galactic

Through an acquisition made by Social Capital Hedosophia, a London and Hong Kong-based special purpose acquisition company, Richard Branson is building the first and only publicly traded commercial human spaceflight company. 

Built with a $600 million commitment two years ago, the SPAC is making an $800 million pledge to Virgin Galactic as indicated by The Wall Street Journal.

Proving technology to be a viable sector for SPACs, backers of the project, listed on the New York Stock Exchange, will focus on suborbital launches to carry out experiments, and tourists, to space.

Space exploration isn’t the only technology being boosted by SPACs.

Technology: The Vanguard of Introductions

In the technology, media and telecoms industry sector, TPC Pace Holdings raised $400 million through an IPO in 2017 and announced in June 2019, a business venture with Accell Entertainment, a leading gaming-as-a-service provider and producer.

For SPAC investors and the companies acquired, the idea of getting through the process and the time commitment for regulatory review is an advantage. The SPAC process becomes normalized and makes considerable benefits available.

As SPACs evolve and shake off the unfounded concerns of early editions, they are being embraced by experienced, established and sophisticated private accredited investors and private equity sponsors.

Investors who invest in a SPAC at the time of the initial IPO have a full vote, are given full disclosures and also maintain the ability of asking for their money before closing the deal. Both the risk and economics work in the investors’ favour.

SPACs are being launched in a variety of industries, including Technology, Media and Telecoms.

SPACs are being used in industries where financing is scarce and while most SPACs go public with a target industry in mind, not all do.

Investors bet on management’s ability to succeed and SPACs are competing directly with private equity groups and strategic buyers for acquisition candidates. The increasing competition between the groups often result in higher bids for the best companies and increased future valuations.

While competition is good, some type of outside regulation is needed to ensure best practices.

For the peace of mind of everyone involved in a SPAC, the rules and regulations of this special type of company are set by the NYSE, the NASDAQ, and the SEC.

Cross-Border Mergers and Acquisitions

Cross-border M&As are emerging as the choice for forward leaning companies as they gain access to new markets and the new customers those markets bring.

According to Global Banking and Finance, the global trend in SPACs points to a growing volume in deals for the second half of 2019.  Competitive dynamics as related to technology and globalization make M&As imperative.

While technology makes the planet smaller, and different sectors meet and new players enter the marketplace, the growing appetite for M&A deals means a promising second half of the year.

The TMT Sector Has a Promising Future

As investors look more at IT targets, IT startups show a great deal of future promise. With an increase of 30 percent from 2018, to more than $330 million, deals increased in number by 29%.

TMT is driving M&A intentions as companies face the need to mitigate risks while navigating regulatory regimes. 

Due Diligence Is The Key Which Opens the Door to Success

Severnaya SPACs exercises due diligence and looks for companies that have long-term value.

Especially interested in technology-based companies with strong fundamentals, Severnaya SPACs focuses on organic growth acquisitions and looks for companies that can demonstrate longevity, from both the management and operational standpoint.

We research companies that have the ability to compound for the long haul and look for four key elements:

  1.      Does the company have the ability to compound over time?

  2.      Are they market leaders, in technology and niche markets?

  3.      Do they have a long history of high cash flow generation?

  4.      Can they be purchased at a reasonable multiple of those cash flows?

One of the advantages for SPACs in Emerging Markets such as Central and Eastern Europe, Middle East, North Africa and Turkey, CIS and Latin America, is the ability for acquisition targets to connect with experienced global investors, who are interested in higher potential growth than can be found in more mature markets.

Severnaya SPACs works with accredited investors looking to acquire businesses in Emerging Markets in the TMT sector. The characteristics of the deal must meet exacting standards, to ensure success, first at the time of the business combination; and sustained stock market growth thereafter.  

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*This article was originally published on LinkedIn on August 20th, 2019

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