Chris Hughes
London’s regime for special purpose acquisition companies serves no one well. Its approach to investor protection is so crude as to have prevented the SPAC market from taking off at all. As the U.K. scrambles to bolster its post-Brexit finance industry, it should not dismiss the U.S. model unless it can devise something better.
SPACs are publicly traded cash shells that merge with private companies. They offer a speedier and more certain route to a listing than an initial public offering. For investors, they provide access to innovative companies that might not qualify for an IPO. Even if the U.S. market is showing signs of overheating, these vehicles have a role. London is seeing potential new issues courted by New York.
Right now, Amsterdam is perceived as frontrunner to become a European SPAC hub. Why is London, the region’s main financial center, being left behind? Ironically, for all its reputation for high standards, it’s because the U.K.’s blank-check regime looks pretty unfriendly to investors. A major obstacle is the listing rules’ “presumption” that unless a SPAC can provide a full prospectus on its proposed merger as soon as it’s agreed, the shares will be suspended. That risk deters investors from committing funds in the first place.
The logic for the requirement is that the blank-check company’s shares could be volatile as investors attempt to value its transformation from cash shell to operating company in real time. That, the reasoning goes, makes the situation more chaotic than when an established listed company announces a takeover.
But investors would surely prefer the risk of some choppy trading to that of not being able to trade at all. U.K. regulators don’t suspend the shares of listed operating companies announcing deals that radically change their strategy or indebtedness. Better to scrap the suspension rule and give SPAC investors alternative protections — like the ability to redeem their cash and to vote on the proposed merger, as in the U.S. A review of the listing rules, due to conclude soon, provides such an opportunity.
The trickier issue is whether the U.K. should explicitly allow SPAC mergers to be accompanied by the release of the target company’s financial forecasts. This is a key feature of U.S. SPACs, and a real attraction for early stage businesses without a track record of revenue, let alone profit. An IPO prospectus includes only historical results. With a SPAC, forward projections may be used to persuade people to back the proposed merger. Sometimes they were already shared with new investors roped in to provide extra funds for the deal anyway.
The sight of SPAC targets that are little more than concept companies making grand claims for the future rightly raises concern. Some, perhaps many, won’t generate the sales needed to escape their history of burning cash.
But allowing U.K. SPACs to do the same wouldn’t be such a radical leap, considering how London IPOs are conducted.
Management teams are able to provide building blocks that help investment bank analysts construct financial models.
After some error-checking via lawyers, the resulting research goes out to institutional investors. (By contrast, U.S. IPOs don’t feature published research.)
This arm’s length process helps assuage directors’ worries about their legal liability for providing clues about the outlook. Indeed, the expensive rigmarole appears designed to create the impression that the forecasts in the research have nothing to do with the company’s own thinking, enabling managers to educate potential investors while feeling protected from claims if shareholders lose money.
The process is opaque and the research ends up mainly in the hands of the big institutions and hedge funds. The retail investor doesn’t get a look. At least the company forecasts in a U.S. blank-check deal are available for the whole world to critique. Management is unambiguously accountable for them. If the business doesn’t deliver, it’s clear where the buck stops.
As for the other controversial aspects of SPACs, they will probably be resolved by market forces. Competition between cash shells should push SPAC promoters, investors and target companies to negotiate terms that share the risks and rewards more fairly. Regulators can help here by demanding that the economics of the SPAC are spelt out clearly for investors. Allocation of a SPAC’s stock to long-term investors in its own IPO would curb the involvement of hedge funds punting on a quick share-price jump knowing they can redeem their cash otherwise.
There is a risk that the U.S. SPAC bubble bursts badly. But the U.K. will be taking a different risk if it doesn’t mimic the vehicles, or can’t make its IPO market similarly attractive. A shortage of new high-tech issues has resulted in woeful returns for the FTSE 100 over the last decade compared to the S&P 500.
Who is regulation really serving? The current practices around IPO research favor the most powerful investors — just as the regulatory-driven dearth of research on U.K. mid-cap companies helps buyout firms take them private without much resistance.
U.S. SPACs aren’t perfect. But it’s far from clear that the ordinary U.K. investor will be helped by thwarting their development in London.
Bloomberg
