A review released alongside Rishi Sunak’s recent Budget suggests the UK aims to become Europe’s leading destination for special acquisition vehicles (Spacs). The move could help reverse the London Stock Exchange’s dwindling share of global IPOs, but their history in the US suggests investors need to take care.
Spacs essentially offer a “backwards IPO” and easy route to market for a private company. They are cash shells, known in the US as blank-check companies, with no commercial operations. They raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company. As the companies have no operations, the disclosure requirements and listing documentation are much easier and less costly.
Britain’s benchmark FTSE 100 index has underperformed global peers for more than a decade due to its low weighting in growth sectors such as technology. Last November, the government introduced The National Security and Investment Bill (NSIB), which will allow it to block the takeover of companies in 17 key sectors, including data infrastructure, communications, quantum technology, advanced materials, and computer hardware. Following the foreign takeover of UK businesses such as chip groups Imagination Technologies and ARM Holdings, defence engineer Cobham and satellite group Inmarsat, this change was clearly overdue.
More routes to market
The listing review, led by former EU financial services commissioner Lord Jonathan Hill, is an attempt to make a London listing more attractive to growth companies. Many of these companies are seeking cheaper alternatives to traditional listings – with the Spac route increasing in popularity in the US.
A number of UK regulations are acting as a deterrent for Spacs seeking to float, particularly the requirement for a trading suspension once an acquisition is announced. This means investors can become locked in their investment for an uncertain time period under current rules.
Lord Hill urged the Financial Conduct Authority (FCA) to issue guidance to companies, conceding that there also need to be rules to protect shareholders, including the details Spacs must disclose to the market and an investor’s position when it came to voting. It also urged clarity over redemption rights, which are important to ensure that, if an investor didn't approve of the target, they can get their money back – plus interest.
The urgency of these changes was underscored this week following the listing of a Spac in the US on Tuesday. Tailwind International raised $345m and aims to build a multi-billion-dollar franchise of European technology companies listed in the US, bypassing UK and European Union stock exchanges. “We will bring one of Europe’s iconic technology companies to the US public market,” its chair, Tommy Stadlen, declared.
Traditional IPOs can be extremely costly, with bankers’ fees running into the millions. This means direct listings have become popular in the US as they bypass the underwriters. Companies that can't afford this route, don't want share dilution, or are avoiding lockup periods often find the direct listing process more attractive.
However, while underwriters give companies certainty of how much they will approximately raise ahead of their flotation, companies using direct listings do not know how much they have raised until their shares start trading. Without this costly intermediary, there is no safety net ensuring the shares actually sell.
So, Spacs have grown in popularity because, in theory, they provide certainty and a potentially cheaper route to market. This led to 2020 being the year of the Spac in US stock markets.
The listing of such vehicles raised almost $80bn in 2020 from 237 flotations, up from the $13.6bn raised in 2019 in 59 IPOs. This trend is accelerating, with $26bn raised in January alone – one third of the amount raised over the whole of 2020.
A bubble brewing?
Until now, things have gone pretty well. As with any modern investment frenzy, an exchange traded fund (ETF) was launched in the US tracking such vehicles in October last year. The Defiance NextGen SPAC Derived ETF, which tracks the performance of the Indxx SPAC & NextGen IPO Index. Its shares are still ahead of the IPO price but have fallen sharply in recent weeks, with some claiming in the US that the Spacs bubble is about to burst. The main area of concern is dilution.
The sponsors of such vehicles tend to get a chunk of shares in the target company as their reward a few months after the target has been found – as much as 20%. So, the attractiveness of these vehicles to their sponsors is clear. That’s why they have attracted big names in US finance – which allows these companies to distinguish themselves from other cash piles with a stock market listing.
Spacs have been sponsored by investors such as Bill Ackman and former Facebook executive Chamath Palihapitiya. But, as investors in funds managed by Neil Woodford after he left Invesco can attest, past performance is no guide to the future.
Getting more technology companies to come to London is clearly an admirable aim. Making the UK stock market more dynamic and growth-orientated will be a win for the City, with the loss of underwriting fees a moot point if the company would not have listed here otherwise. But, should the Spac frenzy come to London, as looks increasingly likely, it’s important to remember that investing in these vehicles is as near to gambling as an investor can get. Beware the dilution – and remember your redemption rights are there to be used.
A version of this article first appeared in the Daily Telegraph.
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