Special purpose acquisition companies (Spacs) are turning to costly new tactics to keep investors from jumping ship as market confidence wanes in the once red-hot alternative to IPOs.
Blank-cheque acquisition firms and the companies they acquire are having to hand over bigger stakes in the ventures to investors in some cases, often at big discounts. Deal managers are also seeking backstop financing from investment companies and ploughing in more of their own cash.
Less than three months into 2022, 13 mergers involving Spacs have already fallen through in the US, according to data from industry tracker Spac Research. That compares with a total of 18 in the whole of 2021.
global co-head of Spac coverage at RBC Capital Markets
In money terms, almost $9.5 billion worth of mergers have been canned this year, according to Dealogic data.
The main cause of deals being abandoned, market players say, is the risk of redemptions – where investors exercise their right to sell shares in the venture back to the Spac before the merger is completed, and for the price they paid for them.
"Every transaction is worried about redemptions and every transaction is trying to figure out how to mitigate it," said Amir Emami, global co-head of Spac coverage at RBC Capital Markets.
The approaches employed by Spacs include offering bonus stock to investors who choose not to redeem shares.
Spacs are shell companies that raise money in an initial public offering and put it in a trust for the purpose of merging with a private company and taking it public. Since investors are unaware of the target company ahead of the IPO, Spacs often grant them the right to redeem their initial investment as an incentive to put their money in the trust.
Yet significant redemptions undermine the viability of such deals. At the same time, shares of many companies that went public during the boom last year have fared poorly, leaving some investors nursing losses and making new Spacs look more risky.
Indeed, the deals are drying up.
Only 24 Spac mergers, worth $28.3 billion, have been announced so far this year, against the 93 deals worth $233bn in the first quarter of 2021, according to Spac Research. Only 48 new Spacs were floated on US exchanges up to the end of February, compared with 214 during the same period last year, according to data from Dealogic.
"What was an attractive deal, say six months ago, may not be as attractive today given the market has sold off meaningfully since then," Mr Emami said.
The icing on the cake
Measures such as offering extra stock have been successful in getting some mergers over the line, yet the tactic can come at a heavy financial cost for the Spac managers, their target companies and their original investors, who become diluted.
"With a high number of Spacs still seeking targets and the scepticism due to the pullback in the market, it has become harder to persuade target companies to want to engage with Spacs and have the related management distraction," said Atif Azher, partner at law firm Simpson Thacher & Bartlett.
Bonus stocks, or "bonus pools", for investors who eschew redemptions, are typically comprised of founder shares or regular company shares that were reserved for the Spac managers.
In January, in the $9.3bn merger of Cohn Robbins Holdings Corp with lottery operator Allwyn, 6.6 million shares, worth an estimated $65 million, were offered to shareholders who elected not to redeem their shares.
"The best way to maximise participation by Spac shareholders is to bring to market a highly profitable company with exciting growth prospects at an attractive valuation. The bonus share reward is just the icing on the cake," Cohn Robbins co-chairmen Gary Cohn and Clifton Robbins told Reuters.
DPCM Capital, another Spac, gave shareholders about five million shares for not redeeming their existing holding in its $1.2bn merger with quantum computing company D-wave Quantum.
Spacs are also raising additional financings, known as private placements in public equity (Pipes), to get deals over the line. About a dozen Spacs have raised additional Pipes in recent months to mitigate the risk of redemptions.
Some of the fundraising is also done via over-the-counter equity derivative agreements. If investors who buy the shares choose not to redeem them before merger completion, the Spac agrees to buy back those shares from them at a later date after the merger is safely in the bag.
Managers pay millions
Some investment firms have also stepped in in recent months to backstop deals. One of them, Atalaya Capital Management, offered Yellowstone Acquisition Company up to $70m for its $777m merger with airport hanger manager Sky Harbour in January, five months after the Spac deal was announced.
In other cases, it is the Spac investors who step up.
Shareholders of Spac Dynamics Special Purpose Corp, for example, including funds managed by Cathie Wood's Ark Investment Management, Morgan Stanley and T Rowe Price, committed $86m in non-redemption agreements in December to help it complete its merger with biotech company Senti Bio in a deal valued at $601m.
Some Spac managers have also chosen to invest more of their own money into deals to make up for redemptions. For example, the parent company of Trebia Acquisition Corp, a Spac that agreed to merge with marketing platform System1 Inc, agreed to provide a $250m backstop in January 2022 for the $1.4bn deal to close.
"Most of the terminations more recently are more market driven," said Michael Levitt, partner at law firm Freshfields Bruckhaus Deringer.
"They [Spacs] are concerned that the redemptions are going to be too high, and the target company is not going to have enough money to meet its minimum cash condition," he said, referring to the specified amount a Spac must hold upon the deal closing.
