Investors are pressuring some blank-check acquisition companies to scale back wildly lucrative payouts to their bosses that are weighing on shareholder returns, threatening to tamp down Wall Street's biggest gold rush of recent years.
Managers of the biggest so-called special purpose acquisition companies (SPACs), which raise money in initial public offerings (IPOs) to merge with privately-held companies, are awarded stock worth hundreds of millions of dollars by only investing millions of dollars of their own money.
Investors have typically acquiesced to such compensation on hopes of handsome profits. But after SPACs raised a record total of more than $70 billion this year, bigger than the last 10 years' haul combined, the intense competition for deals is beginning to erode returns and is triggering a backlash from some investors over what they say has become a "get-super-rich-quick" scheme for SPAC managers.
"Investors are more selective now, they are willing to push back on SPAC sponsors for more favorable terms, and sponsors are more willing to listen," said Evan Ratner, an Easterly Alternatives portfolio manager who has invested in SPACs for 14 years and is now raising a SPAC-focused fund.
Hedge fund veteran William Ackman's Pershing Square Tontine Holdings Ltd, billionaire investor Daniel Och's Ajax I and former U.S. House of Representatives Speaker Paul Ryan's Executive Network Partnering Corp are among SPACs that recently launched IPOs with less favorable terms for their managers than the industry norm.
The managers argue they are aligned with their investors because they also take a hit when the combined company's shares drop, and are often restricted from selling their stock for one year after the deal closes. But they can still be in the black when their investors lose, because their cost to own the shares is only a small fraction of what investors pay.
"(A smaller stake in the company going to the managers) is better for the public shareholders in the SPAC because the sponsors are buying the shares at a discount. Investors would prefer to give away less of the company for a cheaper price than more of it," said Westchester Capital Management managing member Roy Behren, who invests in SPACs.
The climb-down in payout expectations follows several high-profile investment flops that allowed SPAC managers to make a killing.
Veteran dealmaker Michael Klein and his team were awarded $275 million worth of stock last month for merging their SPAC Churchill-III with healthcare services firm MultiPlan Corporation in an $11-billion deal by only investing $25,000, according to SPAC Analytics. Klein's team separately invested $23 million to receive warrants, or options to purchase shares at a certain price, in the company.
The combined company's shares are now trading at 25% less than when the deal closed amid concerns over growth prospects.
Yet Klein and his team are still in the black by more than $200 million, because the shares cost him only a tiny fraction of what investors paid.
A spokesman for Klein declined to comment.
Another prolific SPAC sponsor, Chamath Palihapitiya, is in line for a stock payout that on paper will be worth $207 million after investing $25,000 of his own money in a $3.7 billion merger with U.S. insurance startup Clover Health. He also invested $16.4 million to receive warrants in the combined company.
His SPAC's shares have lost 20% since the deal's announcement in October, as investors fretted the deal may have overvalued Clover.
A spokesman for Palihapitiya declined to comment.
Some SPAC managers are now asking for a smaller chunk of the combined company as compensation than the customary 20% to curry favor with investors and also companies which may ultimately merge with the SPAC. Known on Wall Street as the "promote," it dilutes SPAC shareholders because it leaves them with a smaller ownership of the company. It is also dilutive for the owners of the companies that negotiate mergers with SPACs, often becoming a sticking point in deal negotiations.
Och, who founded hedge fund Och-Ziff Capital Management in 1994, charged a 10% promote, rather than 20%, for his SPAC AjaxI, which raised $750 million in October. Executive Network Partnering Corp, a SPAC where Ryan serves as chairman, raised $360 million in September with a 5% promote, with additional shares to be paid out only based on its share price performance.
Ackman, the founder of activist hedge fund Pershing Square Capital Management LP, decided not to ask for a promote. He will receive warrants that he can exercise to buy a slice of the combined company. There are warrants awarded to all SPAC managers, although Ackman will receive less than the industry norm.
"The big trend you may see in early 2021 with SPACs is lower promotes, which might make the product more attractive to a wider group of prospective target companies," said Alan Annex, co-chair of the global corporate practice at law firm Greenberg Traurig LLP.
To be sure, a manager's promote is subject to further negotiations with the owner of the private company involved in a SPAC merger. While many SPAC managers receive the equivalent of 20% of a SPAC after its IPO, they have been awarded on average 7.7% of the company after a merger in deals between January 2019 and June 2020, according to an analysis by Stanford Law professor Michael Klausner and New York University School of Law
assistant professor Michael Ohlrogge.
SPACs have been around since the 1990s, and even President Donald Trump considered launching one 12 years ago when he worked as a real estate developer, according to people familiar with the effort. He worked with Deutsche Bank AGon the SPAC, dubbed Trump Acquisition Corp, but abandoned the effort when the 2008 financial crisis hit, the sources said.
The Trump Organization did not respond to requests for comment. Deutsche Bank declined comment.
SPACs' track record used to be lackluster, confining them to the backwaters of capital markets. The 12-month stock performance for companies that have gone public through a SPAC merger since 2015 lagged both regular IPOs and the Russell 2000 Indexof small-cap stocks, according to research by Barclays Plc.
The sector took off late last year, when SPACs caught the eye of blue-chip investors who bought shares in high-profile companies such as space tourism firm Virgin Galactic and fantasy sports operator DraftKings Inc . The massive influx of money into SPACs led to unusually big trading gains
for many of them.
SPAC industry insiders and investment bankers now point to the overheating of the sector and pushback against managers' compensation as evidence that the hype of blank-check acquisition companies is fizzling.
"The more that some folks change their promotes, it will put
pressure on others who want to stay competitive to do the same," said Stephan Feldgoise, global head of mergers and acquisitions at Goldman Sachs Group Inc.-Reuters
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