What do Shaquille O’Neal, a basketball legend, and Gary Cohn, former Goldman Sachs MD and Donald Trump’s advisor, have in common? Both have raised multimillion-dollar Special Purpose Acquisition Companies (SPACs). SPACs are also typically called “blank cheque” companies as investors contribute capital without knowing what investments will be eventually made.
Therefore, a SPAC is essentially a leap of faith or, as others may claim, a vote of confidence because successful launch of the acquisition vehicle depends largely on the expertise of the sponsors backing it. A key distinction between SPACs and IPOs is that SPACs take companies public through a merger while an IPO requires a direct listing. These investment vehicles have become extremely popular, but they present significant risks for public investors and for the broader capital markets.
Tidjane Thiam, a former chief executive at Credit Suisse and Prudential, is one of the latest high-profile financiers to join the frenzy. Tidjane’s US$250 million SPAC, Freedom Acquisition I, was incorporated to target “one or more businesses which currently or may in the future have the potential to benefit from disruption caused by the convergence of financial services and technology, driven by the exponential increase in data generation, advances in artificial intelligence and robotics, rising processing power and/or ubiquitous global connectivity through smartphones, among other technologies.”
Tidjane will serve as the Executive Chairman while two of his protégés – Adam Gishen and Abhishek Bhatia – will serve as Chief Executive Officer and Board Advisor, respectively.
Overview of Freedom Acquisition I
What business could Tidjane Thiam’s SPAC be preparing to take public?
Given the size of the investment vehicle, its fee structure and observed market dynamics, I anticipate that Tidjane and his team will look to take no more than two businesses public in the next two years. I also anticipate the businesses to be located either in Asia or in Latin America. Although not impossible, I do not foresee any deal execution in North America, Europe or Africa. The SPAC’s target is likely to be an e-health care, an e-insurance or a payment company operating in a platform-enabling country in Asia or in Latin America. There are more than 300 SPACs with some $100 billion in cash currently seeking acquisitions – the competition is fierce.
The Perils of Blind faith: imbalance economics
There is a significant interest in SPACs as evidenced by this mind-blogging figure: within the first two months of the year, SPAC volume rose to half of 2020’s record.
SPACs are a way to bypass the more onerous and uncomfortable process of an initial public offering (IPO). Blank cheque shell companies do not require the same scrutiny or due diligence an IPO would. And there lies one of the most critical issues of the instrument: the lack of rigor in the due diligence process, especially when the sponsors’ interest is not aligned with investors. In other words, the sponsor does not have a fiduciary duty to the investors in the acquired company.
And this leads me to the other fundamental flaw of SPACs: imbalance economics. SPACs are typically structured in a way that heavily favors the sponsors (i.e. the founders/initial backers): they get a 20 percent stake of the target company at a considerable discount while public investors help raise the investment vehicle size 2-4x. Underwriters such as JPM and Morgan Stanley get to collect generous fees in the process. In this case, SPACs are compensation schemes masquerading as an asset class.
Aligning the interests of sponsors, underwriters and public investors is the only way to avoid exuberance and recklessness amid the SPAC frenzy. Warren Buffet, the Oracle of Omaha, likes to reiterate this old saying, “only when the tide goes out do you discover who’s been swimming naked.”
This article was first posted on Papa Moda Loum’s LinkedIn.