This Insight is part of a multi-part SPAC Roundtable Series: Institutional Recognition and Beyond, hosted by Cowen’s SPAC team.
Much of the recent success of special purpose acquisition companies, or SPACs, is due to a watershed structural change: the separation of the vote and the ability to redeem shares for cash, which allows virtually all deals to be approved. However, it remains critical to raise enough capital for a business to achieve a significant free float, be attractive to investors and meet various exchange requirements. Often times, that requires sponsors and their advisors to succeed in retaining or replacing certain investors with other longer-term holders who want to own the target company.
That undertaking, known as the de-SPAC process, is the most critical part of a SPAC’s lifecycle, according to Chris Weekes, a Managing Director in Cowen Inc.’s Capital Markets Group. In SPAC Roundtable: Institutional Recognition and Beyond, Mr. Weekes said that as SPACs continue to evolve, they have become part of the conversation with most investment bankers with clients who want to sell or go public. He also said that sponsors should look for investment banks, like Cowen, that offer value throughout the process, from the IPO to the search for a target to post-deal support with knowledgeable research analysts. The full interview is below:
SPACs Interview: Chris Weekes
Cowen: SPACs have come a long way, especially in the last couple of years. What has led to recent success?
Mr. Weekes: A few things in my opinion: The quality of the sponsors has improved, the average enterprise value of SPAC mergers has increased, recent strong stock performance and some other structural elements that have changed.
The most notable structural change has been the bifurcation of the vote and the redemption right. In the earlier SPACs, the vote and the redemption right were tied to each other so many deals struggled to receive approval. Before they were separated, investors could amass large positions and impact the outcome of a potential merger. This doesn’t exist anymore.
Now, you can vote “yes” to approve a deal even if you want to redeem your shares for cash. You can also hold onto your warrant, which will only have value if a deal closes. As a result, the vote has become perfunctory. Virtually everyone votes “yes.” Most mergers go forward.
Cowen: Is the bifurcated structure healthy for the market?
Mr. Weekes: Yes, but it doesn’t solve everything. While deals almost always get approved, there is still the need to retain, replace or raise additional capital for the business – this is called the de-SPAC process. The investors in the SPAC IPO don’t always end up being natural holders of equity in the pro-forma business. It all depends on what the SPAC ends up acquiring and if that company fits the investment thesis of the SPAC investor. If there isn’t alignment, the SPAC and the target will need to market the transaction similar to a regular way IPO. In order to raise equity capital and to solve for appropriate free float and other exchange-related requirements, the company will market the transaction to equity investors. They will go on a roadshow, market the story and sell the stock.
Cowen: Are higher-quality participants part of the story?
Mr. Weekes: The entire ecosystem has matured. On the sell-side, there are more underwriters and more advisors resulting in more developed sell-side support. SPAC mergers have become a regular part of the discussion for most investment bankers looking to advise clients on selling or going public. SPACs seem to have become part of the fabric of many institutions.
On the sponsor side, the quality has improved for a number of reasons. One, the amount of assets held in private equity today has exploded beyond what we’ve ever seen. They need multiple exit or liquidity vehicles. A sale to a strategic buyer is one. A traditional IPO is another. A private equity trade or recap is a third. But the private equity market has a finite life for each portfolio company they own. SPACs have become the fourth normal course opportunity for an exit or alternative path to future liquidity.
If you peel back the onion on the regular-way IPO market, there are really only two sectors that have consistently had access to the public markets: TMT, specifically software, and healthcare, specifically life-sciences. In 2019, there were 70 healthcare IPOs, 42 TMT IPOs, and 59 SPAC IPOs. That is really incredible when you think about it.
Cowen: Should we look at success on the front and back end as connected or separate processes?
Mr. Weekes: The front end has become somewhat commoditized. After all, the SPAC unit is just a bond-like security with a low-risk return over a certain period. When considering sponsoring a SPAC though, sponsors should be critiquing the capabilities of their underwriter. Hiring an underwriter that has capabilities that apply to all stages in the life of the SPAC from formation to a post-close public company is important with regard to maximizing return on gross-spread dollars. There can be a disservice to issuers when the underwriter isn’t aligned with all facets of the organization from investment banking, capital markets, research, and sales and trading. Candidly, there are too many underwriters today that raise the IPO money and simply walk away because they have a contract and no ability to continue to support the sponsor.
Cowen: What’s the right amount of cash to raise in a SPAC IPO?
Mr. Weekes: When sponsors look to determine what size SPAC they want to issue, we advise to reverse into what we think the size of the target universe is. These days, the average enterprise value to SPAC IPO proceeds is about 3.5 times. It’s simply an exercise in determining the dilutive impact of the sponsor shares to the merger. If you have a $200 million SPAC and you find a business to buy that is $200 million of enterprise value, your $50 million of sponsor shares will be quite dilutive. Of course, there are ways in which SPAC sponsors can mitigate this issue.
On size, one of the challenges with the very large SPAC IPOs is that the universe of targets shrinks as you get larger. That said, we have witnessed an increase in the size of the mergers in recent deals.
The average SPAC size is approximately $225 million. A $200 million SPAC can merge with a $750 million company with ease, but it can also merge with a $2 billion company because you can always flex up with more capital through a PIPE (private investment in public equity), as we’ve seen many times in recent deals.
Cowen: What’s the major risk to the SPAC market remaining robust?
Mr. Weekes: The biggest risk to the SPAC issuance market is the market itself – as in the stock market. We’ve had consistent gains for the last 10 years in a very low interest-rate environment.
Where SPACs play a really important role is between two goalposts of private-market multiples and public-market multiples. Take the defense sector for example. Private multiples have been trading in the high single-digits while the public-market multiples are closer to 12x to 13x range. The opportunity is somewhere in the middle. You offer a higher multiple than a private trade but a discount to the public market, so it looks like an IPO priced to trade higher.
To the extent that there’s a contraction in that arbitrage, it could impact SPACs negatively.
Cowen: What kind of SPACs have performed best? Is there any common denominator?
Mr. Weekes: Size matters. Many small or microcap companies, both via SPAC merger and regular-way IPO, have struggled in the aftermarket. They’re not indexed, there is little research and minimal float. The ability to properly capitalize companies so they can come out of the gate on the right footing is incredibly important.
At Cowen, we focus intensely on optimizing the de-SPAC process. We help our clients market the story to investors, we deploy the relevant industry bankers, capital markets personnel and salesforce early in the process to help clients both institutional and corporate form a view. Research analysts conduct independent due diligence and are available for investor education. This advice is critical in the de-SPAC process.
Cowen: Is there a limit on how big a SPAC IPO can get?
Mr. Weekes: There’s likely a limit to the size of the SPAC itself because the dilution from the founder shares is based on the size of the SPAC IPO.
Let’s assume a $1 billion enterprise value for the target. A $200 million SPAC with 20% founder shares results in $50 million of equity to the sponsor. If you did the same deal with a $400 million SPAC, the dilution would be ~$100 million.
It’s a balance between capital and associated dilution. There is absolutely a place in the world for SPACs of either size, largely driven by the relative size of the target company.
If you’re a $400 million IPO or greater, you’re either a proven team that’s done it before or you are affiliated with a large asset manager who is part of your sponsor group. Those $400+ million SPACs are likely targeting a $2+ billion deal. There are simply fewer companies in the world with that size.
Cowen: What are some of the hang-ups that caused problems for SPAC deals?
Mr. Weekes: Size, sector, comps, etc. all impact the success of a deal. For example, if you don’t have a clear comparable in the public market, investors might have a tough time analyzing the company. If you fall in between sectors, it can take more time to explain the story to the market. The performance of the comps and of the company itself during the de-SPAC process is critical too. Just like a regular-way IPO, if your closest comparable stock price declines 25% that doesn’t help. If the company you’re merging with comes up short on projections that’s not good.
Cowen: What role does sell-side research play and how does Cowen look at it?
Mr. Weekes: Most banks have pulled away from stock picking and a thoughtful approach to research and it’s become commoditized. This is not new – small cap stocks haven’t garnered the right attention in the market dating back to earlier in the decade with Sarbanes Oxley, Dodd-Frank and other market structure changes (e.g. decimalization). Despite some limitations, we can have research analysts in conversations with our sponsors. At Cowen, research analysts conduct independent due diligence early in the process. We use capital markets people, bankers, and research analysts to help analyze and shape a company’s story to apply to the public markets. The analysts still can’t go on the road, but they are available to educate investors.
Cowen has been investing significantly in our research platform while many banks have been pulling back. We have more than 50 senior publishing analysts covering more than 900 stocks.
Cowen: Does research become a big selling point when you talk to IPO sponsors about becoming their advisors? What else is important?
Mr. Weekes: Our clients that look across the Cowen platform can readily see where the value is. Is there value in having an institutionally relevant analyst? Is there value in trading very large secondary-market trading volume? Of course. We have built our SPAC business with the client in mind. We have a partnership model where we take a holistic approach to everything we do and that must include alignment in the industry and the people.
As a SPAC underwriter and advisor, we’re not a high-volume shop because we’ve elected not to be a high-volume shop. If you come to us and you’re looking for targets that are outside of the industries where we focus, we may not be your best partner.
We think about the sector of the target universe. Then we think about whether that universe is ripe with opportunity. And we also want to make sure a client is the right sponsor – a sponsor who has the ability to source deals, has deep networks, and experience either in a C-suite or as an asset manager with plenty of exposure to transactions. We also want to partner with good people. Our view is that we will be partners for the long-term and we want to enjoy the relationship. That is a key part of our sustainability.
Cowen: Are there any specific advantages to a SPAC versus a regular-way IPO you’d highlight?
Mr. Weekes: One is disclosure. A SPAC transaction allows for forward-looking projections to be publicly disclosed by the target. This is a differentiator since traditional IPOs typically rely on LTM (last twelve months trailing) and analyst estimates. It’s not always easy to factor in future performance in regular-way IPOs
If a company is acquisitive, the forward-looking projections give you the chance to include the pro forma numbers in the forecasts.
Additionally, SPACs have offered the ability for sellers to take more secondary capital off the table.
Another unique feature of a SPAC transaction is that valuation is fixed. The SPAC is not terribly sensitive to what the valuation is as long as it clears the public market. Ultimately, the seller (the target) and the buyer (the SPAC) are both looking for the highest valuation possible. You have to sell as much stock as you can to the market and ultimately, it’s the market that will determine what the right valuation is.
Cowen: How do SPAC IPOs fit into the broader IPO market?
Mr. Weekes: SPACs now represent a large percentage of the overall IPO market. More than 20% in the last three years running. It’s staggering. At the same time, we have seen a significant increase in the number and the size of SPAC mergers so the whole market has really evolved.
See additional parts of this series:
Get in touch
Reach out to us directly for more information.