KUHN CAPITAL Monday, March 19, 2018
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SPAC Primer


Back in the 80’s, a flurry of “blank check” or “blind pool” outfits went public based on the vague promise that the promoters would later find an M&A target whose value justified the investment. Naturally, such arrangements worked out great for the promoters but rarely for the investors. Blank check operators were eventually driven back into the boiler room caves from which many had emerged.

Now comes the increasingly-visible SPAC, or Special Purpose Acquisition Company. What’s different this time around? SPAC’s are more “real”. That it, SPAC’s still go public without an M&A deal in hand, like blank check operators, but at least SPAC management teams seem qualified to evaluate deals in a specific industry, and if they don’t close one in 24 months, the investor’s money is returned. Unlike their blank check cousins, they can’t just pay themselves “deal search fees” till all the money’s gone. Of course, not all investor money is returned: the promoters can keep up to 15% of it.

SPAC’s are designed to compete with PE firms for deals. Think of them as cutting out the middleman. PE firms take investors’ money, combine it with bank debt, buy a company, dole out up to 20% of the equity to management, assess the deal “consulting fees”, dividend the cash from debt back to themselves, and ride their 80% equity position into the future.

In the case of SPAC’s, there are theoretically fewer mouths to feed. SPAC’s do the same thing as PE firms in leveraging and divying up deal equity, but without the PE firm’s cut (20% of equity appreciation plus a fee of 1% - 2% per year on the investor’s commitment) and hopefully without all the personal deal fees. Other SPAC advantages: 1) public stock is more transparent and liquid than limited partner shares in PE firms; 2) smaller investors than those accepted by PE firms can participate, and; 3) if an investor doesn’t like the proposed M&A deal, he can sell out his position.

SPAC disadvantages: 1) Due to excessive regulation, going public these days is expensive and personally risky to management; 2) Some SPAC’s are thinly traded, so getting out can be problematic; 3) the average value of equity raised by SPAC’s is $75M. That limits the aggregate value of the deals they can do to about $250M; 4) SPAC’s are typically specialists in an industry sector, limiting the investor’s ability to diversify sector risk.

All in all, however, SPAC’s represent an improved opportunity for individual investors to play in the current leveraged buy-out money game.

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