alternative public offerings - · pdf filefinancier worldwide ... public initial for...
TRANSCRIPT
FINANCIERWORLDWIDEcorporatefinanceintelligence
www.financierworldwide.com
R E P R I N T E D F R O M
F i n a n c i e r W o r l d w i d e N o v e m b e r I s s u e 2 0 0 6
R O U N D TA B L E
ALTERNATIVE PUBLIC OFFERINGSInvestors Restrained IPO markets and the mounting credibility of alternative capital raising methods
have supported a recent wave of SPACs and other APOs from around the globe. These vehicles are quickly shrugging off their negative stigma and now appeal to more players within the private equity and
venture capital communities as they look to fund entrepreneurial growth prospects. Capital markets are also more receptive. APO structures are becoming more sophisticated, prompting hedge funds and retail
investors to divert more funds their way.
FWM A G A Z I N E
REPRINT | FW November 2006 | www.financierworldwide.com
ROUNDtable
Richard P. Swanson
Partner, Arnold & Porter LLP
T: + 1 (212) 715 1179
www.arnoldporter.com
Richard Swanson is a partner in the firm’s litigation and corporate & securities practices. He
specialises in commercial litigation, with a particular concentration in securities, corporate
directors and officers and professional liability, bankruptcy, creditors’ rights, insolvency and
banking litigation. In the area of securities litigation, Mr Swanson has handled Rule 10b-5
class actions, derivative suits, partnership cases, securities cases involving public offerings
and private placements, insider trading cases, and accountants’, lawyers’ and directors’
liability and malpractice actions. He has also been involved in numerous tender offers, proxy
contests and other corporate takeover matters.
Simon Luk
Partner, Heller Ehrman LLP
T: +852 2292 2222
www.hellerehrman.com
Simon Luk joined Heller Ehrman in 1993 and has an international, corporate securities,
China private equity and commercial practice. His clients include multinational corporations,
financial institutions, Chinese issuers, major Hong Kong trade associations and industrial and
emerging companies. His projects have included cross border mergers and acquisitions, SEC
compliance work for Chinese issuers, purchase of assets and brand names for Asian clients,
China private equity, listing of American Depository Receipts and litigation in the US. He was
elected as a highly recommended lawyer for China private equity work by PLC.
Barbara A. Jones
Partner, Kirkpatrick & Lockhart Nicholson Graham LLP
T: +1 (212) 536 4898
www.klng.com
Barbara A. Jones maintains a diverse corporate and securities law practice across industry
groups, emphasising complex international and domestic transactions, including private and
public financings, PIPEs, alternative exit strategies, dual listings, mergers and acquisitions
and licensing transactions. Her work extends to complex regulatory reporting and compliance
issues arising in connection with her transactional work and representation of public listed
US and non-US companies. She is vice-chair of the ABA Subcommittee on International
Securities Matters.
Steven M. Skolnick
Member, Lowenstein Sandler PC
T: +1 (973) 597 2476
www.lowenstein.com
Steven M. Skolnick is a Member of Lowenstein Sandler PC in Roseland, New Jersey, where he
is a member of the firm’s Specialty Finance Group and M&A and Corporate Finance Practice
Group. He has been very active in representing underwriters and issuers in public securities
offerings, including both initial and secondary offerings. He also has extensive experience
with PIPEs, SPACs and convertible equity and debt offerings representing placement agents,
institutional investors and issuers.
Timothy P. Halter
Chairman and CEO, Halter Financial Group, Inc.
T: +1 (972) 233 0300
www.halterfinancial.com
Since 1987, Timothy P. Halter, founder of Halter Financial Group, has been principally
involved in over 75 reverse merger transactions. He is a frequent speaker on the topic and
a commentator on national business news networks. In addition to Halter Financial Group,
Inc., Mr Halter is the founder and Co-Managing Director of the Halter USX China Index and a
member of the Board of Directors of the National Investment Banking Association.
Deborah Salerno
Managing Director, DAS Consulting LLC
T: +1 (212) 750 3355
www.dasconsultingllc.com
Deborah Salerno is the managing director of DAS Consulting LLC and Horizon Capital Fund
LP. She advises companies seeking public listings and capital raising through the use of
reverse merger/PIPE transactions. She has been a principal in two dozen blind pool and Form
10 SB shell companies since 1987 and participated in numerous PIPE transactions.
THE PANELLISTS
Cynthia M. Krus
Partner, Sutherland Asbill & Brennan LLP
T: +1 (202) 383 0218
www.sablaw.com
Cynthia M. Krus has been involved in numerous public and private securities offerings.
She serves as the Practice Group Leader of the firm’s Securities and Corporate Governance
practice and counsels clients on a broad range of matters. Ms Krus advises companies on the
structure and formation of various entities and the establishment and operation of private
and public venture funds, including small business investment companies and business
development companies.
ROUNDtable
www.financierworldwide.com | November 2006 FW | REPRINT
8
How has the market for SPACs and other alternative public offerings (APOs) evolved over the past two years?
Salerno: The lack of a favourable environment for initial public offerings, particularly in the micro- and small-cap sector, has ne-cessitated alternative means of raising capital, such as SPACS and PIPEs. A rapidly growing Chinese economy coupled with the desire by those Chinese companies to have a presence in the US capital markets, as well as other rapidly expanding emerg-ing-economies, have fuelled a demand for capital-raising in forms other than the traditional IPO. For example, in the SPAC market, while the deal size has remained stable at approximately $75m, the total funds raised saw a doubling in 2005 from 2004. Likewise for 2006, it’s expected that there again will be a double over 2005’s result, in terms of total monies raised using this structure.
Jones: The market has really gathered momentum, acceptance and credibility over the past 18 months in particular. Bulge bracket banks like Citigroup, Deutsche Bank and others have served as lead investment banks on SPACs. This is a significant change from two years ago. I recall that in August 2006 alone there were 10 SPAC acquisitions announced. This is key insomuch as in prior years there were a number of SPACs registered with the SEC, but very few deals. We are now seeing real deals being done with the SPACs. Similarly, activity with other APOs has been steadily in-creasing. Different types of players have entered the market, such as private equity and venture capital groups seeking exits for their portfolio companies. Hedge funds have also become active. We are seeing a greater interest in the SPAC and APO vehicle from non-US companies, as well as US companies using an APO to list over-seas or a US SPAC seeking a merger with a non-US company.
Krus: SPACs have been around for some time but they did not gain much attention initially. Offerings were in the $20m to $30m range, smaller investment banks tended to lead them and the man-agers involved were not as experienced in these vehicles as man-agers are today. But there has been huge growth in this area. In 2005, SPACs accounted for 12 percent of the IPO market, rising to 22 percent in the first quarter of 2006. A recent SPAC completed an IPO in the $300m range, which attracts the attention of bulge bracket investment banks, which in turn involves more attorneys at larger firms and leads to changes in the structure and sophisti-cation of such deals. The industry is coming into its own, having raised over $4bn since 2003. This has encouraged private equity firms to consider different ways to access the public markets, such as KKR’s $5bn private equity fund on Euronext. So although the SPACs are in their infancy, they are growing quite dramatically.
Skolnick: As a result of the cost and difficulty in completing tra-ditional public offerings, the market for SPACs and other APOs has increased significantly over the past few years and these types of transactions have become more widely accepted by investors specifically and the marketplace generally. One of the reasons for
the increased acceptance is the increased quality of the deals that are being completed. Another is the increased amount of money that is available to hedge funds and private equity funds and that must be put to work. Given the availability of this money, the funds are looking for additional avenues in which to deploy their capital. SPACs and APOs present a home for this capital.
Swanson: SPACs and reverse mergers, and their second cousin PIPEs, continue to be popular ways for smaller, more speculative companies to raise capital and gain market liquidity, both inside and outside the United States. They are more accepted mecha-nisms of financing today than they were as little as two or three years ago.
Halter: We have seen a big change with the development of the APO market over the last two years. Our firm did our first APO in January 2005, raising $17m for China BAK Battery. We had about 20 institutions (mostly hedge funds) participate in this deal and for all of them it was their first involvement investing in an APO. In this particular deal the story and valuation made it very attractive and most of the investors viewed the deal as somewhat of an experiment. By all accounts the deal has been very success-ful. This specific transaction has been great but the bigger per-spective is that the APO model was proven and accepted by many well known and well respected hedge funds.
Luk: SPACs, particularly reverse takeovers (RTOs) of US listed shells, have been gaining popularity recently because of huge US and international investor demand to invest in profitable Chinese companies in traditional businesses. The successful fundraising has legitimised this process. Also, the recent entry of many repu-table second tier investment bankers in this market has raised the quality and standard of disclosure in these transactions.
The rise of the APO market is seen by many as a US-led devel-opment. In your view, how popular are these methods really proving to companies and dealmakers outside of the US? Which regions or countries would you say are most active in taking advantage of them?
Jones: Canada, Europe, India and China have been the most active in pursuing APOs, both within the United States as well as on foreign exchanges, such as the TSX, AIM, Euronext, Hong Kong and Singapore. There is a steady flow of companies from these countries and regions. Dealmakers are able to consider the most appropriate exchange for a particular APO, which may not be in the US. This has increased deal flow overall, but particularly in the US, as it has given US companies alternative markets for their shares without being subject in the short and medium term to the rigors of Sarbanes-Oxley.
Skolnick: While there are a significant and increasing number of APO deals being completed, there also is a growing effort on
foreign capital markets, including the AIM, in particular. We have seen an increase in the number of privately owned foreign operat-ing companies, especially companies in China, that are utilising reverse mergers in order to tap into the US public market place. We have also seen an increase in the number of companies, both US and foreign, that are utilising the AIM market in the UK due to the ease of listing and lower transactional and compliance costs compared to US transactions.
Salerno: The growth of the APO market has been impacted by the economic growth in China. US firms have moved into China anticipating their need for capital and creating a means for access to the capital markets in the US through the use of reverse mergers and SPACs. While the US has been at the forefront the UK has also provided entry to the capital markets through offerings on the AIM and PLUS markets.
Halter: The APO transaction has been well received by compa-nies outside the US as a quick and less risky way to enter the US capital markets. We have focused on China over the last few years and have completed nine APOs for Chinese companies raising an average of $17m each. China is currently the hot market for APOs now, but we are seeing other international opportunities. We cur-rently have in our pipeline deals from Russia, the Czech Republic and Chile.
Swanson: Most alternative public offerings have been done in the US, but many have been done in other countries. Many of the non-US APOs continue to be completed by foreign com-panies accessing US markets. Chinese companies are good ex-amples of this. Various exchanges in Canada have also proved popular for APOs, as well as Germany. While the UK has seen some, the regulatory flexibility available on the London AIM market has led to an increased use of standard IPO
methods on the AIM and less APO activity in London as a result.
Krus: Although KKR’s public fund is listed on Euronext in Europe, it does not provide KKR with access to retail buyers in the US, as only qualified investors in the US can participate. Also, I’m not sure Europe will ultimately turn out to be a big enough market to handle many publicly-listed private equity funds. Indeed, Apollo’s fund is currently the only follow-on to the KKR fund. A number of SPACs are listed on the AIM but my under-standing is that the issue with the AIM comes down to liquidity. It may take a couple of years to solve this, so in the meantime the SPAC market will be predominantly based in the US, where many more have raised capital. In the US, the private equity in-dustry is more mature and the amount of capital at hand is greater. Buyout shops are seeking different outlets for different funds, and they will most likely concentrate on the US while still looking to access European markets as much as possible.
What impact are these alternatives having on capital markets?
Halter: Success breeds success. We are now seeing larger compa-nies interested in APOs than in the past. We are also hearing from well known VC and private equity firms that are looking at the APO alternative for the first time. There is definitely a momentum in this industry at the present time.
Krus: Some of the SPACs raised in the US are also focused on in-vestments in various other countries, including the faster growing economies of China, India and Israel, so they will obviously have an effect on those countries. In the US, the dollars raised by private equity firms in the past year has outpaced the value of the IPO market by several multiples. One reason is that it’s almost impossible to read a newspaper these days that does not mention the private equity industry. Consequently, retail investors are be-coming far more comfortable with private equity and that makes it easier to raise funds in a Business Development Company (BDC) structure, for example. Also, companies are staying private longer and they require financing while they grow to a maturity level that allows them to come to market and deal with regulatory costs as-sociated with Sarbanes-Oxley and other public company require-ments. This dynamic is driving private equity dollars towards buyouts and going-private transactions.
Salerno: First of all, it has opened up the capital markets to com-panies that would otherwise be shut out, allowing these compa-nies to grow and expand to their full potential. They are likewise bringing to potential investors the opportunity to participate in these types of companies, and please note, I’m not just referring to start-up companies. The lack of interest on the part of the tra-ditional investment banks and analysts has allowed the capital markets to more freely determine the value of these shares, not 8
Retail investors are becoming far more comfortable with private
equity and that makes it easier to raise funds in a Business
Development Company (BDC) structure, for example.
CYNTHIA M.KRUS
REPRINT | FW November 2006 | www.financierworldwide.com
ROUNDtable
ROUNDtable
being subject to prognostications and other actions typically taken by the bankers that may influence pricing. Additionally, rather than the shares being launched at an arbitrarily-determined public offering price, with the result being a far more volatile launch, the markets themselves determine the value.
Jones: They have provided new investment vehicles for hedge funds and other institutional investors. We are certainly seeing this in the SPAC market, as well as PIPEs and reverse mergers. In addition, these alternatives are fuelling activity within certain overseas markets, particularly AIM, Euronext and the TSX. Hong Kong and Singapore have seen increased activity in 2006 as well, as Chinese, Indian and other companies in the region consider alternatives to a US APO. In addition, these alternatives are pro-viding new life for existing listed companies whose share price has been in a steady decline and are at risk of losing their listing or have already lost their listing. An APO can provide such a company with a synergistic merger and consequent boost back onto an exchange, or it can use the APO to spin-off current activi-ties into a private company and leave existing shareholders with a new operating company, presumably with better future prospects. It must be noted, however, that the improvement in the US IPO market in 2006 has resulted in a decrease in reverse merger activ-ity, at least through the first half of the year.
Skolnick: Even though there was a large increase in the amount of money invested in the PIPE market over the last few years, many funds continue to look for alternative transactions to deploy their capital. SPACs and other APOs have provided additional vehicles for these funds. The jury remains out on whether these structures will survive if and when the traditional public offer-ing market returns, and whether the regulators will further curtail these markets.
Swanson: APOs give liquidity to smaller, more speculative enterprises that otherwise might not have it. As such they can serve as useful vehicles for capital raising for more entrepreneurial and growth-oriented sectors of the market. They also help to encourage private equity and venture investments in these sectors as they make it easier for early investors to see more flexible exit strategies.
Have there been any significant developments in the struc-tures, methods and techniques used by professional advisers in this area of the market?
Krus: SPACs are very structured transactions. They are unlike IPOs of operating companies as they are offering units, there is usually some investment by the founders, there is a trust structure where the vehicle must hold the cash and can only access that cash in certain limited circumstances until a business combination is complete, and they have a limited life of 18 to 24 months. An increase in the number of SPACs coming to market has induced
some changes for the better. For example, historically the amount of money going into trust was around 85 percent; now it is around 95 to 100 percent. Also, the amount of money involved in these deals is significant enough to allow people to finance the search for a transaction with the interest generated by that money, which was not a possibility in the past. Another development is that since investment bankers obtain their fees through the transac-tion, they have actually been required to put a portion of their fees into the trust and are only paid out when a business combination is made. So people are becoming more sophisticated about invest-ing in SPACs.
As far as BDCs are concerned, there was a huge movement towards them back in the spring of 2004. After Apollo raised their BDC, about 12 IPOs were filed – but only a couple of them actual-ly went through because the market lost interest in these vehicles. As a result, people have reverted to the two things that investors demand (1) that the fees charged are more reasonable, and (2) that the fund has an existing portfolio or a track record; for example, a private fund is being taken public or acquired from someone else. Ultimately, investors do not want their money sitting idle for some time.
Another type of entity is a STAC, a Structured Trust Acquisition Corp, which is essentially a trust on top of an LLC. These vehicles operate almost like an investment company, with an external man-agement team, but their structure means they do not fall under the Investment Company Act, since they comprise several portfolio companies that are being held for control, which makes it similar to a mini-Berkshire Hathaway. Until a couple of years ago this structure was unheard of, and more buyout funds may look at it in the future. The structure is attractive in situations where no single portfolio company would be able to IPO on its own. The fee struc-ture also provides an attractive yield to investors.
An APO can provide such a company with a synergistic merger and consequent boost back onto an exchange, or it can use the APO to spin-off current activities into a private company.
BARBARA A. JONES
8
www.financierworldwide.com | November 2006 FW | REPRINT
Salerno: More hedge funds are investing much like their private-equity counterparts, and both are or will be seeking exit strategies. The APO allows the managers to convert their holdings in the private company to shares that can be converted to cash, not as a single sell transaction, but over time. Further, the equity markets can then independently value the worth of a company, affording the investment managers some level of comfort that the returns are being maximised upon the liquidation of the position.
Luk: The SEC has now required US reporting companies in-volved in RTO transactions to provide the same detailed infor-mation as that of an IPO, such as description of business, risk factors, management discussion and analysis. Audited accounts of the operating business to be injected are required. For the APO market in London, disclosure has been reduced to a minimum, which adds to its attractiveness. However, the lack of regulation and disclosure may impact the viability and interest of long term investors in the APO markets.
Jones: The key development has been the movement of these techniques offshore to non-US exchanges. This allows the issuer to avoid – at least for some period of time – compliance with Sarbanes-Oxley; however, liquidity can vary, as certain exchang-es appeal more to an institutional market than a broader base of investors.
Skolnick: It is very clear from our discussions with some of the US regulators that APOs are, and will increasingly be, more intensely scrutinised by regulators than other capital markets transactions (a level that continues to rise). The regulators have told us that they recognise PIPEs and APOs are important fundraising transactions for the small- and mid-cap public companies; they have said that
these transactions are not ‘bad’ but, instead, some of the people who are involved in these transactions are ‘bad’. The regulators perceive that these transactions have a greater tendency of at-tracting bad actors than other transactions, and therefore require greater scrutiny. As a result, the deal structures are always evolv-ing, whether as a result of changes required by the regulators or by the investment community. For example, in the SPAC market, we are seeing higher percentages, closer to 100 percent, of the pro-ceeds that are being placed in the trust account for the benefit of the public stockholders. This is primarily the result of a push by the in-vestors, who have become more sophisticated, for more protection and a higher level of risk taking by the insiders and the bankers, thereby resulting in increased upfront investments by the insiders in the form of equity purchases or loans and deferred fees by the bankers. In the current market, it is much harder to get a deal com-pleted without a higher escrow amount. Another structural change resulted from SEC scrutiny last spring related to dissolution and the stockholder approval processes. Some SPACs are now being formed as limited life companies. Therefore, if the business com-bination is not completed in a timely manner, the entity dissolves pursuant to the terms of its charter without having to seek board or stockholder approval. This provides more certainty that the dis-solution will be completed quickly, at lower costs, and the public stockholders will receive their money on a faster timetable.
What are the most significant legal and regulatory develop-ments to hit SPACs/APOs, and how have they impacted the growth of this market?
Halter: The SEC came out with certain rules related to the re-quired disclosure for reverse mergers and APO transactions in August 2005. The SEC now requires companies completing these types of transactions to file disclosure documents similar to that of an IPO. A company doing a reverse merger or APO today has exactly the same regulatory requirements as any other public company including compliance with Sarbanes-Oxley. We believe that the increased regulatory requirements have the market effect of weeding out many of the less quality deals while at the same time giving a level of comfort to investors. This has been a very positive thing for this industry.
Jones: While SPACs have garnered greater acceptance among the US regulators, reverse mergers and PIPEs remain subject to intense SEC scrutiny. This scrutiny has not quelled the market, but it has required participants to make adjustments to their transactions in response to current SEC concerns. Outside of the US, the key regulatory development has been the establishment of an electronic settlement system for Regulation S securities. The inability to settle Reg S securities electronically has long been considered a significant disadvantage for US companies trading on AIM. The new system, provided through SIS, is expected to enhance liquidity for Reg S securities trading offshore and eliminate the ‘Reg S discount’. 8
A company doing a reverse merger or APO today has exactly the same
regulatory requirements as any other public company including
compliance with Sarbanes-Oxley.
TIMOTHY P. HALTER
REPRINT | FW November 2006 | www.financierworldwide.com
ROUNDtable
ROUNDtable
8
Skolnick: Many issuers are seeing the difficulty in getting the review of their proxy statements for their business combinations completed by the SEC in a timely manner, which can have dire consequences to the issuer since they have a deadline, generally between 18-24 months from the effective date of the public of-fering to complete their business combination or else they have to dissolve since under their charter. These provisions cannot be amended to increase the time periods.
Luk: For the RTO market, the SEC’s recent regulations concern-ing the substance of disclosure in an 8K has eliminated many companies who had no realistic chance of successfully attracting funds. Because disclosure is as much more detailed, only com-panies with good earnings are now raising funds through a RTO. Increasing investor interest has prompted many reputable invest-ment banks to enter into this market to raise the quality of overall disclosure.
Krus: Regulators are much more focused on SPACs. Whenever there is a migration towards this many deals, this fast, greater regulatory scrutiny is almost inevitable. The SEC has raised a couple of accounting issues and questions over investment banking fees. They are also looking closely at management teams: Who’s sponsoring these deals? What are their inten-tions? Do they have an acquisition in mind? Have they made any progress towards an acquisition? SPACs are blind pools and sponsors are restricted from pre-selling to a company that’s not public. Another issue centres on what happens to the company if it is unable to execute an acquisition. How would it be treated under state law? How would it liquidate? Nevertheless, I think the market has propelled more structural changes than the regu-lators. Also, most SPACs were not previously listed on an ex-change and traded on bulletin boards. But now that the American Stock Exchange (AMEX) is involved, five or ten SPACs have listed. The fact that these vehicles have been accepted by AMEX gives them more credibility. The process surrounding them is also taken seriously, such as making sure investment banks have the right background, that they are selling the SPAC to the proper number of investors and that there will be real liquidity in this market. So regulators are looking at SPAC IPOs to make sure that nothing is amiss.
Swanson: The SEC does not favour the use of APOs, as a SPAC or a reverse merger involves companies going public without any of the traditional disclosures or due diligence. There is also limited underwriting activity in the case of a typical APO, so that source of investor protection is missing too. In that case, a SPAC investor buys not knowing how their funds will be used or what will be acquired. In the case of a reverse merger a private company merges into a public shell and becomes public without there ever having been a prospectus. And yet the SEC knows it can’t stop these deals. It even knows they have a useful purpose in certain segments of the market. Where you have to be careful
is where the SEC, or prospective investors, have the sense that the APO is accompanied by market manipulation or even insider trading. Then big trouble can result.
What are some of the advantages and disadvantages of APO vehicles, particularly in comparison to traditional IPOs?
Skolnick: Advantages of an APO include a much quicker time-frame for completion, more certainty in completing the deal, less cost than a traditional IPO and no need for underwriter or market-makers. Disadvantages include less public float follow-ing completion of an IPO, limited or no analyst coverage, limited liquidity and no assurance that a true market for the securities will be created post acquisition. Many of these transactions are viewed with scepticism.
Krus: Private companies that undertake a combination transaction with a SPAC or a STAC are able to avoid the uncertainty of getting through the regulatory process associated with IPOs. It is a way for those private companies to go public in a market that has not been favourable to IPOs. A number of companies have prepared for an IPO but had it withdrawn. An APO may be one option that a management team did not pursue previously, but which the present market has made more attractive because it’s difficult to predict when investors will again be receptive to traditional IPOs. Private companies have a lot more choices available to them today. They can stay private longer because of the capital that has been raised by private equity, they can try to go public through a SPAC or they can sell the company in a business combination transaction. So there are a number of different ways that a company can approach the financing issue during their mid-cap stage.
Advantages of an APO include a much quicker timeframe for completion, more certainty in completing the deal, less cost than a traditional IPO and no need for underwriter or market-makers.
STEVEN M. SKOLNICK
www.financierworldwide.com | November 2006 FW | REPRINT
8
Salerno: The unfavourable IPO environment has forced issuers to explore alternatives, and investors have more readily embraced these alternative financings. Couple that with the fact that the al-ternative financings are less costly to the issuer to complete, can be accomplished in far less time than a traditional IPO, and have been favourably received by investors. The liquidity and transpar-ency of these shares in the marketplace is less than those of a tradi-tional IPO and usually they don’t have the following of traditional investment banks and analysts, but I believe that regardless of the status of the traditional IPO market, the alternative public offering market is here to stay and will continue its explosive growth.
Jones: The principal advantage continues to be greater certainty as to pricing, timing and cost than the traditional IPO. The price is negotiated with the investors in advance, thus making the transaction less susceptible to intermittent volatility in the market. There is greater flexibility in the ability to negotiate key terms of the transaction as well. Disadvantages include heightened regulatory scrutiny – manageable with knowledgeable advisers – and after-market support which should be considered and planned for in advance.
With a number of vehicles available – including SPACs, private 144A IPOs, reverse mergers, trading and non-trading shells and offshore listings – which options are proving most popular with private equity firms looking to exit their investments?
Swanson: It is hard to generalise but the larger the deal the less likely they are to be done by reverse mergers and shells and the
more likely they are to be done by SPACs as most SPACs are sponsored by recognised houses and their investors at least knew what they were getting into when they purchased their shares, even if they didn’t know what specific acquisitions might be made. In the case of shells, the investors may have bought when the original operating company was still around and they had no idea how their shares might be used. 144A deals are very popular and very legitimate since QIBs are sophisticated investors and they know how to protect themselves and get the disclosures they need. Offshore listings, especially the London AIM, are also popular and quite legitimate.
Skolnick: I believe that the SPAC market has seen the most in-terest from private equity firms in the past year, since they po-tentially provide the investor with a more liquid investment. I still believe that there is a reluctance by private equity firms to get involved in reverse mergers, other APOs and the like due to the limited liquidity and lack of analyst coverage following the closing of these types of transactions. Many private equity firms have not bought into the mainstream role these transactions play in the capital markets, and they continue to focus on the stigma that used to be attached to companies who ‘did one of these trans-actions’.
Krus: This really depends on the management team’s goals. For example, one recent STAC transaction provided an exit for four portfolio companies from one entity, allowing them to be private to some extent despite being in a public structure. But this would not work if the sponsor held only pieces of those companies, rather than full control, as it would need to be structured as a business development company and be regulated under the Investment Company Act of 1940. If the management team is willing to run a public entity there are more possibilities and a greater variety of investments, such as debt to equity.
Jones: Clearly the reverse merger with a concurrent or follow-on PIPE has been the most attractive vehicle for the private equity groups. Many are now considering offshore exchanges for these transactions as well, provided the portfolio company has some base of operations in the local region or country. The key development here is that these groups are no longer feeling constrained to a US-only listing. There’s a real reluctance to subject their investments to US compliance burdens and uncertain, volatile markets, when better options may exist offshore. Interestingly, SPACs are now being considered by some private equity groups as a more viable option than once thought. The end result – a listed portfolio company providing liquidity to the private equity investors – is the same, just a different method of achieving it. The key issue to be worked out is with respect to the SPAC management team and the portfolio company’s management team – can they co-exist in some form for a limited period, or do certain participants need to be bought out?
Regardless of the status of the traditional IPO market, the alternative
public offering market is here to stay and will continue its explosive growth.
DEBORAH SALERNO
REPRINT | FW November 2006 | www.financierworldwide.com
ROUNDtable
ROUNDtable
8
How has investor demand for these types of offerings changed? To what extent are hedge funds fuelling the rise in APOs?
Luk: Hedge funds have been fuelling the rise in APOs. As being public is already a good result for some hedge funds, ease of listing the APOs (often within a week or so) is very attractive. Although there is little fundraising and trading is thin, the exist-ence of a public market for the hedge funds may mean a good performance in their investment portfolio.
Salerno: Public opinion on alternative public offerings has dra-matically changed, in fact the New York Stock Exchange through their merger with Archipelago is a prime example of just how mainstream they have become. PIPE transactions, once held to be a last-ditch effort of a failing company, have now found wide-spread acceptance with investors and potential investors realis-ing that the mere mention of ‘PIPE’ does not connote a company ‘circling the drain’. As a result, the universe of participants in al-ternative offerings has increased. Hedge funds are indeed playing a large role in these offerings – they are run by professionals, generally with extensive backgrounds in the securities industry, who can more easily understand and embrace new investment possibilities. Further, as the general public becomes more invest-ment-savvy, the professionals are constantly on the lookout for new investment opportunities that will offer superior returns. The pros generally lead the way with new investment products, and are doing so again.
Jones: Hedge funds have certainly played a significant role in the development of the APO market, particularly in the SPAC market where hedge funds are able to limit the volatility of their returns and maintain a significant upside potential. Hedge funds also continue to be key players in the PIPE market, where dis-counts to market enable them to realise short-term gains once they are able to trade the securities in the open market.
Halter: The APO allows a company to go public and raise capital in a completely controlled private process. The reverse merger or going public part of the process is guaranteed because the public shell is identified up front. The PIPE or capital raising part of the APO is a private placement process that allows the companies to get in front of investors to determine demand and valuation before any public disclosure or regulatory filings are required. The first time that a company doing an APO is required to submit disclosure documents is the day that the deal closes and the company is funded. In an IPO a company must go through the entire SEC filing and review process prior to getting in front of investors. This process is very costly and time consuming and it is only after this is completed that a company will be in a position to gauge investor interest.
Skolnick: Demand for these types of transactions tends to be cyclical. During the last year, there were a number of very large
SPAC transactions that were consummated and the market in general for SPACs was very active. In addition, the number of reverse mergers that were consummated over the last year has also increased. However, recently we have seen a slow down in the number of SPAC IPOs that are being completed. The market appears to be saturated and investor interest, including hedge funds which have certainly fuelled a lot of this market, seems to have slowed. It appears that the successful SPACs in the near future will be smaller deals with very strong management teams in a niche market.
Krus: Investors are becoming much more sophisticated about transactions and are more adept at assessing them. Hedge funds have been significant investors in SPACs. Despite some fail-ures, hedge funds will likely continue to participate in the SPAC market because of the use of warrants and the SPAC-related pro-tections that are available and the potential ability to make good returns.
Swanson: Hedge funds are of course helping fuel APOs because any segment of the market where there can be informational, li-quidity and trading inefficiencies is something they are interested in investing in.
What protections do SPACs afford to investors? Have these protections contributed to the rapid growth of the SPAC market?
Krus: The development of protections over time has definitely made the market more comfortable about investing in SPACs. One example is putting the assets or money raised into a trust,
Hedge funds are of course helping fuel APOs because any segment of the market where there can be informational, liquidity and trading inefficiencies is something they are interested in investing in.
RICHARD P. SWANSON
www.financierworldwide.com | November 2006 FW | REPRINT
REPRINT | FW November 2006 | www.financierworldwide.com
ROUNDtable
which has escalated to 100 percent in some cases. That gives investors confidence that they will get their investment back. The working capital remains untouched since the management team is able to use the interest generated from it as working capital. Equally important is the fact that shareholders must approve the transaction, which is particularly encouraged by long term holders who want a say in what the company is going to become. In addition, only one or two of these vehicles have liquidated, and these failures have not yet caused investors to stop investing.
Jones: The ‘put’ feature in a SPAC makes it a low-risk invest-ment. Investors who do not approve of a particular merger are en-titled to return their units and receive their investment back, less administrative fees. This is not the only contributor, however, to the development of the SPAC market. Returns on SPACS that have completed acquisitions trade on average 27 percent over initial issuance. The general rate of return for all SPACS is in the high teens, making it an attractive investment with low risk.
Skolnick: Although there are several structural protections for investors, the key protection for investors in the SPAC market is the escrow of a significant portion of the offering proceeds into a trust fund that is solely for the benefit of the public shareholders in the event a business combination is not consummated by the deadlines set forth in the issuer’s charter. In such an event, the money in the trust gets distributed out to the public stockholders. In addition, money in the trust fund is available to those public stockholders who elect to convert their shares into cash in the event they do not want to remain a stockholder following the consummation of a business combination. In the past, deals with
around 90 percent of the offering proceeds placed in the trust fund were accepted by investors. However, in the past year and even more recently, investors have pushed for a higher percentage, even as high as 100 percent, of the proceeds to be placed into the trust fund. The deals that we are seeing now are much closer to 100 percent. This has forced the insiders to put more of their own money into the deals in the form of equity purchases or loans and forced the bankers to defer a portion of their fees until the consummation of a business combination. This has also created a market where private equity and hedge funds are getting into the deals in the early stages to help satisfy some of these financing needs. We are starting to see some new structures being formulated, some of which do not initially provide for an escrow, but I feel that without a significant escrow or other protections, it will be difficult to get those deals financed.
Swanson: The principal protection which a SPAC provides to in-vestors is the faith they have in the SPAC sponsor. The principal structural protection is the provision in most SPAC documents that if at least one acquisition hasn’t been made in a fixed period of time, usually 18 months, the money will be returned.
Are you seeing any particular developments in the financing techniques behind APOs?
Luk: At the moment, fundraising is not a main attribute of the APO market. Many issuers have used this market to create an image of being publicly listed. More work needs to be done to create liquidity and promote reputable players to enter the APO market and to raise funds successfully, the primary purpose of a capital market.
Krus: I’ve already mentioned that more of the capital raised is being put into trust and underwriters are deferring some of their fees until consummation of the business combination. But another point to make is that more corporate governance is being introduced into these SPACs – partly as a result of being listed on AMEX. They are establishing legitimate independent directors who are on the audit committee, for example. They are building a number of such corporate governance requirements into their structures, as opposed to having an investment banker under-take that role. Another area worth mentioning is the issue of how much needs to be invested by the founding shareholders. There is a continuing need to ensure that the founders are financially committed, and investment bankers will often require a personal investment by the founders.
Jones: Concurrent PIPEs have become a mainstay for a reverse merger transaction. This affords the company not only an oppor-tunity to attract institutional investor interest, but also the ability to build a war chest for acquisitions. We are seeing more com-panies choosing the ‘reverse merger plus PIPE’ route in order to obtain listed shares for use in acquisitions. 8
More work needs to be done to create liquidity and promote reputable players to enter the APO market and to raise funds
successfully, the primary purpose of a capital market.
SIMON LUK
ROUNDtable
With offshore listings proving to be a viable alternative to US domestic markets, what factors are driving US companies and their investors to consider foreign listings? Which markets are proving most popular?
Jones: The key factor driving US companies offshore is compli-ance with Sarbanes-Oxley. The SEC is continuing to evaluate the impact of the compliance burden on micro-cap and small compa-nies. There is an increasing sense that some relief will be forth-coming in 2007, particularly with respect to Section 404 regarding internal controls. Practical relief from the compliance burden would have a very positive impact on keeping these companies in the US markets. Another regulatory issue relates to deregistra-tion from the SEC’s reporting requirements. Under the current rules, companies can deregister their securities and ‘suspend’ their Exchange Act reporting requirements. However, they cannot actu-ally ‘terminate’ these reporting requirements. The SEC is consider-ing relief on this issue for non-US companies and it is hoped that similar relief will ultimately be made available to US companies as well. The rules currently serve as a deterrent to US registra-tion given that a company can never really ‘exit’ the SEC report-ing regime. As noted earlier, the principal exchanges receiving the benefits of this move offshore are AIM, Euronext,TSX, Hong Kong and Singapore.
Skolnick: In our practice, we are seeing a greater interest in AIM as an alternative to the US markets. The primary drivers behind this is the speed in getting approved, the lower cost of listing and regulatory compliance and the lower level of regulation – issuers do not have to comply with Sarbanes-Oxley for instance. Having spent some time in London speaking on this topic and meeting with lawyers who represent issuers on AIM, the one inaccura-cy that exists is that many feel that this market is not regulated. However, this is simply not true. There is regulation that issuers, bankers and stockholders are comfortable with, it just does not rise to the level of regulation that US issuers need to comply with, a level of regulation that many believe has gone beyond the bounds of what is necessary. The question that remains is whether or not these alternative markets will create the liquidity and stability to make them a home for issuers and investors.
Swanson: The most popular alternative investment market is clearly London’s AIM. Most people think that it is Sarbanes-Oxley which is driving companies away from the US but I don’t really believe that, as the most onerous thing about SOX is the in-ternal control requirements and they haven’t kicked in for smaller companies yet and may never do so.
Krus: Everyone is conscious of the fact that Sarbanes-Oxley compliance requirements for US-listed companies are, at the very least, driving US companies to consider other options, such as going private. In addition to Sarbanes-Oxley, the Investment Company Act raises issues with respect to affiliated funds, which I think helped to drive KKR’s fund abroad. Another issue is the
length of the SEC review process, which has been elongated due to a large number of companies copying the SPAC model. Whereas normally a company would expect a 30-day comment process for the first round and then 5-10 days for the next two or three rounds, we are seeing at least 30 to 45 days for a SPAC on the first round and at least another 30 days for the second round. Since management teams who sign up for the SPAC IPO process cannot be out soliciting business until funds are raised, they must refrain from soliciting target businesses during the review process, which obviously drives a need for speed. As a result, people look to the AIM and a couple of SPACs have gone public there instead. The length of the review process should become less of a factor as the SEC grows more comfortable with the variety of APO structures and also starts drawing on more resources to review them in a shorter timeframe. So regulatory schemes and timing issues are pushing people away from US markets, and in today’s world sophisticated players will continue to access whatever avenue for capital is available. But the main issue when going abroad, especially for APOs, is the liquidity level. There has been a certain amount of disenchantment about liquidity in some foreign markets, and we will see how this affects the decision to list outside the US going forward.
Luk: Heavy SEC regulations and risks of litigation are causing many US companies to consider offshore listings. Sarbanes-Oxley compliance plus auditing and system controls expenses often add $1m to a company’s annual expenditures. For small and emerging companies, this may affect the profitability of the issuer adversely with no immediate discernible benefits.
In an attempt to access financing available through the public equity markets, there has been a noticeable increase in the use of APOs by private equity and venture capital firms. What factors are driving this trend and what methods are most ef-fective?
Krus: Private equity has matured as an industry and fund man-agers are trying to find the most effective way to raise capital. Accessing public dollars is an attractive proposition; it can be done efficiently in the US using the right vehicle, and a number of BDCs have gone public and completed secondary transactions to continually fund their deal flow. A traditional private equity fund requires six to eight months raising a new fund and then harvesting it, whereas BDCs provide a permanent source of capital. Another avenue is a SPAC. There are two kinds of SPACs. One involves operating managers and the other involves private equity manag-ers. Whether this vehicle will continue to be attractive to private equity remains to be seen, as it has only been a viable option within the last two years, and only seven SPAC business combinations have actually been accomplished to date. Quite simply, private equity players will look for results. Whatever the outcome, these vehicles are just another avenue; they will not replace traditional private equity fundraising. The concept of a private equity fund that incorporates a piece of public funding is likely to become 8
www.financierworldwide.com | November 2006 FW | REPRINT
more commonplace, although there will be a large base of insti-tutional investors who are drawn to the traditional structure and have no interest in the public portion of a private equity fund. However, including a public vehicle in the fund allows private equity fi rms to ensure they encompass a greater variety of inves-tors, in particular more retail investors.
Jones: Private equity and venture capital groups are turning to the APO to get a more reliable return on their investment without being subject to the continuing volatility and unpredictability of the IPO market. PIPEs have proven to be a reliable and ready access to funding on more favourable terms than may be other-wise available.
Skolnick: The hedge funds, private equity funds and venture capital fi rms have substantial, if not record, amounts of capital to deploy. APOs are another vehicle for these funds to deploy their capital and this has helped to fuel this market place and the in-crease in the number of deals that the market is seeing.
Swanson: Private equity and venture fi rms invest in all sizes of companies and for some of their smaller portfolio investments, if they can exit quickly and cheaply, they like that. APOs give them that fl exibility.
How has the rise of Business Development Companies (BDCs) and SPACs changed the fundraising market for private equity fi rms?
Swanson: BDCs have some special SEC rules that facilitate them. The fact that private equity fi rms can look at BDCs and SPACs as exit devices can give them a bit more confi dence that they have an exit strategy. The result is that in the marginal case it can give them the confi dence to make an acquisition or a funding that they otherwise might pass on. As such APOs help facilitate the deal market and capital raising.
Jones: On the one hand these vehicles create a certain amount of competition for funds, but not for the large LBO funds or funds with good track records. Newly formed funds and funds focused on emerging growth companies are the most susceptible to com-petition with BDCs and SPACs for institutional money -- at least theoretically. I am not aware of any particular fund that has been unable to raise money due to the rise of BDCs and SPACs.
It is estimated that in the last few years the SPAC industry has raised more than $3bn. Do you believe this presents signifi -cant competition for the private equity industry?
Krus: I think there are only so many good deals out there, so to some extent this has created more competition for large buyouts in the past year. But, again, these vehicles are just another avenue. There are a lot of different ways for companies to participate in the market. For example, BDCs provide signifi cant
mezzanine fi nancing, so it’s not unusual to see a private equity backed transaction with a layer of mezzanine fi nancing from a BDC. Players are also taking different positions and sometimes providing capital throughout the capital structure. In certain cases, private equity funds are using their public vehicles to co-invest with their traditional funds in buyouts, although there are some limitations surrounding affi liated transactions. Publicly traded private equity is also enticing to retail investors, who can buy into a private equity fund through the public markets, and benefi t from the expertise of top tier funds and their managers.
Jones: It represents competition for funds, but I don’t consider the competition signifi cant. SPACs represent a different risk/return profi le than a private equity or venture capital fund. Fortunately, there appears to be signifi cant institutional money available for both. Funds that have had a more diffi cult time with recent fun-draising are the newer funds without a track record. However, at the other end of the spectrum, the large LBO funds are now com-monly raising $3bn-plus in their new funds, which is in a whole different league from the SPAC industry, where the typical raise is under $100m per deal.
Swanson: I don’t see SPACs as competition for the private equity industry so much as just one part of it, and also a means for pro-viding the private equity industry with liquidity. I think the two sectors can continue to co-exist quite nicely.
Skolnick: This is one of the bigger questions in the SPAC market. There is a signifi cant amount of money available for acquisitions by SPAC issuers that have completed their fi nancing, many of which will need to complete deals within the next 12 months or so or dissolve. There will be intense competition among issuers and between issuers and private equity fi rms. Many issuers have been selective with the amount of money raised and have focused on those acquisitions that may not be of interest to private equity fi rms because the target is not in the right niche or that may be too small for the private equity fi rms to have interest in. However, there are other issuers that will be looking to consummate a deal that is in the sweet spot for private equity fi rms, and these of course will be much tougher to complete. Also, private equity fi rms have a big advantage over these issuers – they do not have a fi rm dead-line within which to complete a transaction. They have the luxury of being able to wait and in the event the deal gets delayed, to extend the time period for completion. The other issue that con-tinues to exist is whether issuers in the SPAC market will overpay for the acquisition since they are legally required to use at least 80 percent of their net assets at the time of the business combina-tion. Lastly, there has been increased scrutiny and review of the proxy statements by the Securities and Exchange Commission in connection with these business combinations, thereby increasing the length of time needed to complete the business combination. As a result of this uncertainty in timing and ability to complete a deal, targets may fi nd a transaction with a private equity fund as more attractive.
This article first appeared in Financier Worldwide’s November Issue 2006.© 2006 Financier Worldwide Limited. Permission to use this reprint has been granted by the publisher. For further information on Financier Worldwide and its publications, please contact James Lowe on+44 (0)845 345 0456 or by email: [email protected]
REPRINT | FW November 2006 | www.financierworldwide.com
ROUNDtable