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For blank-check IPOs, popularity comes at a price
NEW YORK |
NEW YORK (Reuters) - Blank-check companies have been some of the hottest initial public offerings in recent months, but hedge funds with an eye for profit may be short-circuiting them, a trend that could end up stunting the IPO market.
Blank-check companies, or special purpose acquisition companies (SPACs), which use proceeds from share sales to fund future acquisitions, can work well. Retailer American Apparel Inc was acquired last year by one.
SPACs raised nearly four times more in 2007 than in the year before, bolstered by a credit crunch that sidelined competitors like private equity firms that rely on debt to make acquisitions.
But SPACs, which sold more than $12 billion of shares last year, have run afoul of investors like hedge funds -- who can demand that the companies return cash if they don't like a potential acquisition.
"Some of the difficulty for SPACs in completing acquisitions is the entrance of what might be described as activist investors," said Brett Goetschius, publisher of DealFlow Media, which collects data and has a newsletter on SPACs. "Investors can essentially 'greenmail' the SPAC management to buy out their shares in order to get acquisition approval."
SPACs float shares with the intention of funding acquisitions -- which must be approved by a certain percentage of shareholders, whose money may otherwise be returned at a possible expense to the SPAC sponsors or underwriters.
Investors such as hedge funds have recently pushed against acquisitions, with the number of shareholders favoring a transaction falling short of the level required for approval. That means the SPAC may have to liquidate and return investor funds -- potentially giving naysaying shareholders leverage over sponsors that could otherwise bear some of that cost.
"SPACs have had increasing challenges with their shareholder votes in the last year," said Thomas Ivey, a partner at Skadden, Arps, Slate, Meagher & Flom LLP, who works on the offerings.
"There's a fine line between a realistic check on a sponsor and having a deal structure that can incentivize a small group of shareholders to hijack the process and hold it hostage," Ivey said, referring to the threshold of shareholder approval required to complete an acquisition.
Blank-check company Harbor Acquisition Corp HAC.A said this month it was considering liquidation after shareholders failed to approve an acquisition. Last month another SPAC, HD Partners Acquisition Corp HDP.A, said it would dissolve after shareholders did not approve an acquisition.
Harbor and HD share many of the same hedge fund investors. For example, as of December, Dallas-based HBK Investments LP was a top institutional investor in both, according to Reuters data. HBK did not return a call for comment.
In response, SPACs have sought ways to thwart activists -- such as raising the threshold of shareholders needed to stop an acquisition, which has historically been 20 percent.
"We have increased the threshold to reduce the risk of a small group of stockholders exercising undue influence on the approval process," K Road Acquisition Corp, a SPAC with a 40 percent threshold, wrote in an offering document.
Another approach is capping the amount of stock an investor can convert into cash after voting against a transaction. Trian Acquisition I Corp TUX.A said in a filing that such a limit was intended to prevent shareholders from using "the conversion right as a means to force us or our management to purchase their stock at a premium to the then current market price."
As a further backstop to completing a deal, if a potential acquisition is announced and Trian's shares fall below a particular value, an affiliate of its sponsor will buy up to $75 million of shares from investors, according to the filing.
Those measures could prove costly. If a SPAC acquisition is approved without a substantial percentage of shareholders signing off, completion may be jeopardized by a lack of funds.
Either could be expensive for sponsors or underwriters, who may ultimately be on the hook for expenses like offering fees.
"The protections for shareholders are extraordinary," said Phillip Goldstein of Bulldog Investors, which manages about $500 million and recently launched a dedicated SPAC fund. "But for a sponsor it's high risk and high reward."
With the increasing amount of risk, some sponsors are questioning if this market is so good for SPACs after all. And a few are hesitating with plans, according to market sources.
"There is no question that the terms have been getting more investor-friendly and less favorable to sponsors," said Skadden's Ivey. "It will be interesting to see whether that reduces the likelihood that sponsors will want to launch new SPACs."
(Additional reporting by Dan Wilchins; Editing by Braden Reddall)
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