Spac roulette: the biggest jackpot on Wall Street
As we’ve been telling you over the past few days, private equity executives have it pretty sweet. So it takes a lot to make them envious.
But the eye-watering profits reaped by dealmakers behind special purpose acquisition companies, or Spacs, might just do it.
Take former Citigroup banker Michael Klein, for example. A group of investors led by Klein merged their first Spac, Churchill Capital Corp, with Clarivate, a little-known data analytics company, in 2018.
As is usual with sponsors when they set up a vehicle, they put in $25,000 for a 20 per cent stake in the Spac equity. Today they’re sitting on more than $400m worth of winnings.
This is all a benefit of something called the “promote” and it helps to explain, at least in part, why Spacs have become the hottest product on Wall Street.
An analysis by DD’s Ortenca Aliaj, Sujeet Indap and Miles Kruppa found that promotes for four sponsors behind 10 Spac deals formed over the past two years are now worth a combined value of almost $2bn. Collectively, sponsors would’ve put in $250,000 upfront. Not a bad ratio.
That kind of windfall has led some, like the short-seller Carson Block, to label Spacs “the great 2020 money grab”. His hedge fund Muddy Waters announced on Wednesday that it’s betting against MultiPlan, another company that Klein took public via a Spac.
Shares in the company are now down about 30 per cent to $6.30, significantly below the $10 price at which investors buy into the Spac’s initial public offering. Klein and his investment group still stand to profit from the deal with a promote worth close to $90m.
The promote is viewed as payment to the sponsor for setting up the vehicle, finding a target and executing the merger. The problem is, with incentives being as lucrative as they are, it may lead some sponsors to strike a deal even when it’s not necessarily with the best company.
That’s the argument Block makes in the report outlining his short thesis on MultiPlan. “A business model that incentivises promoters to do something — anything — with other people’s money is bound to lead to significant value destruction on occasion,” he wrote.
Things are rarely this simple, though. Many of the sponsors that Ortenca, Sujeet and Miles investigated have other means to align their interests with shareholders. For example, Klein’s group will put in hurdles linked to a company’s stock price so investors can’t just dump the stock once the deal is done.
Chamath Palihapitiya and the British investor Ian Osborne, who together have launched six Spacs and are currently sitting on a $370m promote for taking Richard Branson’s Virgin Galactic public last year, will put more of their own money into the deal. Other sponsors agree to give up a part of their founder shares to get a deal done.
But the reality is, success is hard to come by in the Spac world. When we looked at deals struck between 2015 and 2019, two-thirds of the vehicles that found targets were trading below the $10 IPO price.
Despite that, sponsors often stand to make millions from the deals.