SPACs as a hiding place in bear markets

Posted by: Aaron Pressman on June 26, 2008

I’ve never been a big fan of special purpose acquisition corporations, or SPACs. Those are the publicly-traded pools of money raised to give some financier or other a source of funds to do one or more unknown future acquisitions within a set time, typically two years. If the dealmaker finds a target and shareholders approve, the funds are spent and the newly acquired company becomes part of the SPAC’s portfolio. If no deal comes up, investors get back their money plus interest (minus the costs of taking the SPAC public in the first place).

Reminds me of a closed-end fund. You don’t really want to buy at the IPO, when you may suffer an immediate 6% or 7% loss to the underwriting fees. You can avoid that immediate hit buying after the IPO.

There’s also sometimes a question about excessive fees and deals where funds from a SPAC are used to cover only a portion of an acquisition. You have to ask whether the SPAC manager’s interests are always going to be aligned with those of a SPAC shareholder. And after acquisitions are completed, SPAC share prices tend to be quite volatile. Generally, investors would be better off in a simple stock index fund. A Bloomberg article on the SPAC market noted that over the past five years, the vehicles provided an average annual return of just 6% versus the S&P 500’s 13% average annual gain.

So I was surprised and interested to hear fund manager John Osterweis, who runs the Osterweis Fund (OSTFX), at the Morningstar conference in Chicago talking about owning a SPAC as a good bet in a down market. Osterweis, whose fund has beaten the S&P 500 by 3 percentage points a year since 1993, was on a panel of undiscovered fund managers. Despite his stellar record, the Osterweis fund still has just $350 million in assets.

Osterweis likes the SPAC being run by activist hedge fund manager Nelson Peltz, which is called Trian Acquisition Corp (TUX). He was impressed with Peltz’s efforts to improve performance at H.J. Heinz (HNZ) and thinks the SPAC is a smart way to follow in Peltz’s footsteps.

But he also says a SPAC is a good place to hide in a tumultuous stock market, like we have so far this year. If Peltz makes an acquisition, the shares are likely to go up in price. Until then, Trian keeps the cash in trust. If no deal materializes, Trian gives the cash back plus any interest. “It’s a great bear market investment,” Osterweis says, breaking the pieces down as a surrogate cash holding plus an option on a future Peltz deal. “I can’t figure out how we could lose money on it,” he says. “But it’s not the kind of thing we would invest in in a raging bull market.”

Reader Comments

Ty Schlobohm

June 27, 2008 1:00 PM

I implore you to take greater pride in your efforts on this article and do some further homework.

"Reminds me of a closed-end fund. You don’t really want to buy at the IPO, when you may suffer an immediate 6% or 7% loss to the underwriting fees. You can avoid that immediate hit buying after the IPO."

The Spac sponsor invests 3-5% of gross proceeds in the form of warrants that are 100% at risk. This investment aligns the sponsor's interest and mitigates the cost of the underwriters fees. Moreover, the underwriters typically charge 3% upfront and defer the balance upon the successful consummation of a merger or acquisition.

I'd be happy to educate you about SPACs so as to allow you to offer a viable article. I believe a writer at such an esteemed magazine should be held to a higher standard.

Aaron Pressman

June 27, 2008 1:41 PM

Ty, thanks for the comment. I haven't done an in-depth investigation of SPACs. I did notice that TUX, for example, was sold at $10 and now trades around $9.35. That reminded me of the trading pattern of closed-end funds.

Academic research has found some pretty ugly returns for shareholders versus sweet returns for sponsors. For example, see http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1018242

"In this paper, we document various aspects of these companies and IPOs and analyse the returns earned by shareholders and management, from their issuance date to the post-acquisition date. Our results show that the shareholders of blank check IPOs earned minus 3% annualised abnormal returns, whereas management earned approximately 1900 percent annualised return. It looks like the investors essentially wrote a blank check to management."

David S

June 27, 2008 6:51 PM

SPAC investors and managers are not aligned. The managers get a one-way option and have huge incentive to close a deal. Aaron, your instincts are correct.

Gerry Fershtman

July 1, 2008 2:23 PM

Aaron,

I've been involved in many SPACs and if played correctly the investment offers (IMO) tremendous upside potential with limited to no risk. I'd be glad to explain, you have my email.

When you responded to Ty, you mentioned that TUX was trading at $9.35.This is the price of the common stock. What you failed to include is the fact that there is a warrant component (TUX-WT if you look it up on Yahoo Finance), that is included in the IPO offering of every SPAC, and you must combine the price of the common share with the warrant to get the total value of the investment(all SPACs are sold as units; each unit consists of at least one common share and one warrant).

Trian units,TUX-U (if your looking at Yahoo finance) currently trade at $10.10, so investors are actually up 1%, not down 6-7%.

TUX (the common stock) last traded at $9.26, TUX-WT (the warrant) last traded at 80 cents.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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