After a frenetic quarter for special purpose acquisition companies (SPACs), the fad around this listing alternative is coming to “a more normalised cadence” with stakeholders growing warier of its potential risks, according to international law firm Morrison & Foerster (MoFo).
Initial public offerings (IPOs) of US SPACs plummeted to 13 in April, compared to record highs in the first three months of 2021 when the number of SPAC IPOs continued to trend upwards month-over-month to hit 110 in March, statistics from MoFo showed.
“That [frenzy of SPAC IPOs] is coming off an extremely high pace… We’re seeing some caution from a number of different sectors, from regulators [in the US] and investors. And with that, the process has slowed down, but it still remains fairly robust,” said Mitchell Presser, co-chair of MoFo’s Global Corporate Department, during a webinar on Wednesday. “We’re really coming to a more normalised cadence.”
Number of SPAC IPOs (Jan 2020–Apr 2021)
A SPAC is a shell company with no operating business, but a pool of capital raised through an IPO that it uses to take a private firm public. Following a SPAC IPO, proceeds are placed into a trust account; while the SPAC typically has 18-24 months to complete a merger with a target company – a process usually referred to as “a de-SPAC transaction.”
The signs of waning in April followed a feverous dealmaking quarter. In Q1 2021, over 300 SPACs raised roughly $87 billion, which already surpassed the $75.4 billion that the sector raised across 247 SPAC IPOs in all of 2020, according to MoFo data.
The dive, said Presser, was partially because the US regulators started to put out “very cautionary statements” around SPACs.
The US Securities and Exchange Commission on April 8 released a statement, signaling that SPACs could receive the same scrutiny as IPOs. In the statement, John Coates, acting director of the SEC’s Division of Corporation Finance, said the agency was reviewing filings and seeking clearer disclosures for SPACs, and detailed concerns around fees, conflicts, and sponsor compensation. “With the unprecedented surge has come unprecedented scrutiny,” said Coates.
The statement called into question whether SPAC warrants, which give the right to buy a share of stock at a certain price and are traditionally considered equity instruments for accounting purposes, should be classified as liabilities.
“That really caught everyone off guard,” said Justin Salon, a Washington-based partner at MoFo. If the warrants are classified as liabilities, a SPAC would need to update the valuation every quarter, instead of just at the initial issuance of the warrants when the SPAC is formed. It could “change the landscape for SPACs,” he said.
De-SPAC transactions (Jan 2020 – Apr 2021)
For SPACs that have closed their de-SPAC mergers, and SPACs that have gone public but have yet to acquire targets, they are reassessing their financial statements to determine whether they have characterised warrants incorrectly; whether changes in their financial statements would be material; and whether a restatement would be necessary, said Salon. While for companies in the process of a SPAC, they are largely sitting on the sideline waiting for more clarity.
At the other end of the spectrum, the California-based law firm recorded a backlog of 427 SPACs now in the market searching for targets – another reason that its partners believe to have left investors tentative.
“The market started to get nervous that they won’t all be able to find good targets,” said Presser. “At the same time, we also saw some de-SPAC transactions, which had been consummated based on very strong projections of quick increases in sales and growth, started to not pan out… [leading to] some shareholder litigations. That also put a bit of a damper on the market.”
SPACs in Greater China
SPACs, currently still a US phenomenon, are poised to spread across other regions including Greater China, where technology innovations and abundant capital have nurtured a large pool of privately held companies that could be potential targets for de-SPACs.
“You would be surprised if you look at the number of Hong Kong, mainland-based sponsors who have listed SPACs in the US,” said Marcia Ellis, a MoFo partner based in Hong Kong. “Certainly, it is not anywhere near the number in the US, but that is expectable because the wave is really, in many ways, just starting there.”
SPACs are gathering steam in Greater China. Earlier this month, a SPAC led by sponsors including Asia’s private equity (PE) firm CBC Group’s founder Fu Wei, filed to raise up to $200 million to acquire a healthcare business with “a strong China nexus.”
Plus, a Silicon Valley-based autonomous truck startup backed a range of Chinese investors including Sequoia Capital China, agreed to go public by merging with a SPAC in a deal that valued it at about $3 billion.
The growing list of SPAC backers also includes Adrian Cheng, the third-generation scion of one of Hong Kong’s wealthiest families, who launched a SPAC in March to raise up to $345 million. Another Hong Kong billionaire Richard Li, who had already raised about $900 million via two US-listed SPACs, was reportedly considering setting up a third SPAC, according to a Bloomberg report in February. Chinese alternative investment firm CITIC Capital last year raised $240 million for a SPAC targeting domestic energy efficiency and technology businesses.
Hong Kong, where the funds raised through IPOs came only after Nasdaq in 2020, is among several Asian bourses mulling the potential of allowing SPAC listings. Its Financial Secretary Paul Chan Mo-po in March said that he had instructed the city’s securities regulator and stock-market operator to explore suitable listing regimes that include SPACs, as the financial chief seeks to enhance Hong Kong’s competitiveness as a fundraising hub.
While the local authorities have yet to reveal any concrete plans, Li Ruomu, a MoFo partner based in Shanghai, said that Hong Kong regulators have “more of a paternalistic oversight role as compared to their US counterparts” that leaves a question on whether it would take the step forward.
“The difficulty in Hong Kong’s consideration to adopt SPACs,” said Charles Li Xiaojia, the former CEO of the city’s stock-exchange operator, at a conference in March, “is a SPAC cannot be used as a way to get around listing requirements.”
Hong Kong has in recent years tightened rules to prevent so-called back-door listings and the use of shell companies as listing vehicles to improve corporate governance. The city’s securities watchdog considers back-door listings as a way designed to circumvent vetting that is intended to weed out low-quality and unsuitable assets for smaller investors.
According to MoFo, another important difference between the regime in Hong Kong and that in the US is the ability to bring shareholder class action lawsuits. The regime enables investors, who bought or sold a firm’s publicly traded securities and suffered from an economic injury as a result of the firm’s violations of the securities laws, to file a lawsuit.
Due to the absence of shareholder class action lawsuits as a “back-end backstop,” Hong Kong regulators have to be “more vigilant at the time of listings” and gain more information for the vetting process, said Ellis.
The question for Hong Kong would be “whether they will be able to adopt exactly the same features as SPACs in the US to offer the flexibility and certainty to become really attractive to investors in targeted companies,” Shanghai’s partner Li added.