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A Hard Shell

Managers of special purpose acquisition companies, or SPACs, are on the hunt for merger targets.
David M. Katz, CFO.com | US
March 31, 2006

Don't be afraid of Robert Kay. Yes, as chief executive officer of Global Technology Industries, a fledgling special purpose acquisition company, or SPAC, he's looking to acquire a company — maybe yours. But he says he's not a job threat to the CFO of GTI's as-yet-unknown target.

That's true even though Kay is a former finance chief himself. He served as senior vice president of finance and CFO of Oxford Resources Corp., a NASDAQ listed consumer finance company (now known as Nationsbank Auto Leasing), from 1994 until Oxford was sold to Bank of America in 1998. Later, he headed up finance at Tiffen Manufacturing Corp., a maker of photographic and imaging products.

Management teams of other SPACs might choose to place themselves at the helms of the businesses they acquire, but the CFO of a company melding with Kay's SPAC would likely stay put. Unlike private-equity managers looking for a quick turnaround, he contends, his purpose is to use GTI as a platform to build companies over a relatively long haul. Indeed, a good finance chief might be part of the lure of an acquisition target. "You want to look at talented management that wants to grow its business," he says.

Still, Kay and his partners have a long way to go before they join the current wave of new SPACs and start their quest to acquire an operating company. Having filed an S-1 with the Securities and Exchange Commission on March 17, they have to wait for an approval, perform a road show, print a red herring (a preliminary registration statement), and launch an initial public offering over the course of the following two months or so.

In contrast to the cash raised by other kinds of IPOs, most of the funds spawned by an offering like GTI's remain in a trust account and are invested in government securities until the management team's goal is fulfilled. For most SPACs, that goal is to use those funds to buy a privately held operating company in a barely specified industry.

In GTI's case, the industry is "industrial technology." The reason for the vagueness is that, under securities law, the managers of a SPAC have an extremely tight deadline — 18 months from its initial registration — to come up with an apt operating-company mate. Given that time frame, they need an extremely broad universe for their search.

Practical though such cloudiness of purpose may be, it has lent a certain taint that even the current squeaky-clean generation of SPACs can't seem to entirely shake. Long known as "blind pools" and "blank check" companies, they seemed at first to ask investors to place too much faith in the management teams who put them together.

In the 1980s, "pump and dump" scams provided ample fuel for the doubters. In perhaps the most notorious deal, participants orchestrated a sham IPO for a shell called Hughes Capital Corp and acquired all the offered units. Then they artificially inflated the securities' price by spreading false information about Hughes Capital's expansion plans and sold the securities at a hefty profit.

Nevertheless, sporting new investor safeguards, the structures have re-emerged in a big way. Since 2003, sponsors have launched IPOS for about 50 SPACs, raising about $3.33 billion, according to The Reverse Merger Report. Ten of those have announced mergers and six have completed them.

Largely financed by hedge funds and rich investors, some of the deals hitting the market have impressive sophistication and heft. On March 22, shareholders of privately held Jamba Juice approved a merger with a SPAC named Services Acquisition Corp. The deal would be partly funded by a private investment in public equity (PIPE). Under the terms of the agreement, which has yet to be approved by the SPAC's owners, shareholders of the prominent fruit-smoothie maker would get $265 million in cash.

The merger payouts — plus scads of working and expansion capital — would be funded by the $127 million in the SPAC's trust fund and the $232 million in proceeds from a previously arranged private investment in public equity. The PIPE would be issued when the merger closes. (Jamba Juice officials won't comment until the merged company issues a proxy.)

Compared to launching IPOs on their own, private companies can raise growth capital more easily and cheaply by merging with a SPAC, promoters say. Further, because the shells are new entities, they're relatively free of the past baggage of liability. They also offer target companies the chance to avoid taxes by accepting stock rather than cash in the merger, according to a white paper by Integrated Corporate Relations, a financial communications consultancy.

Despite such advantages, SPACs only started to emerge when investor capital for straight IPOs became less available to smaller companies after the stock-market bubble burst. As a result of consolidation in investment banking business, local firms like Alex Brown & Sons in Baltimore and Hambrecht & Quist and Robertson Stevens in San Francisco also were no longer around to underwrite IPOs in the $20 million-to-$60-million range. That left the field open to bankers that could help bring private companies public in another way.


To strip away the vehicle's stigma, SPAC advocates like investment banker David Nussbaum built in safeguards aimed at preventing promoters from hoodwinking investors. Seeking legitimacy for the vehicle since the early 1990s, Nussbaum, the chairman of EarlyBird Capital, worked out the template used by most of the current batch of SPACs with the SEC, he said at an ICR conference call in January. (Last week, EarlyBird reported that it had "received an inquiry from the NASD" and that it is "cooperating fully.")

Under the structure devised by Nussbaum, management teams, which collect no salaries, also hold 20 percent of the stock and must purchase warrants — both of which become worthless if they can't arrange a merger.

Typically, sponsors of the deals put 85 percent to 95 percent of the proceeds into the trust accounts, with the remainder going to legal and administrative costs. The money is only released when the merger happens; if it doesn't occur within the deadline, the funds are returned to the SPAC's shareholders.

Critics of the deals can even have a hard time calling them blind pools these days, since shareholders get to see the company they're buying before they buy it. After a likely target is unearthed by the SPAC's management team, a majority of shareholders must vote in favor of the deal and no more than about 20 percent can choose to liquidate their shares for the merger to go ahead.

Still, the uncertainties SPAC investors inevitably face in the early going still rubs some people the wrong way. "How can you invest in something you don’t know about?" asks Gregory Sichenzia, a partner with the Sichenzia, Ross, Friedman, and Ference securities-law firm. "That’s why I think they're flawed."




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