One of the special studies on SPAC: the past life and present life of SPAC

Introduction

The Stock Exchange of Hong Kong ("SEHK"), a subsidiary of the Stock Exchange of Hong Kong (SEHK), announced a consultation summary on (SPAC), a special purpose acquisition company, on December 17, 2021, and the new rules will come into effect on January 1, 2022. At this point, the SPAC listing mechanism, which continues to heat up in the global capital market, has officially landed in Hong Kong. What on earth is SPAC? What are the advantages and disadvantages of SPAC compared with traditional IPO and other listing models? What is the difference between the Hong Kong version of SPAC and the SPAC mechanism in the United States, Singapore and other places? From now on, Dr. Niu's team will launch a series of articles to sort out and interpret SPAC from different dimensions.

What is SPAC?

The English full name of SPAC is (Special Purpose Acquisition Company, "SPAC", which refers to a shell company with no commercial operation. The main purpose of SPAC is to raise funds through the initial public offering (Initial Public Offering, "IPO"), and then use the proceeds to acquire an unlisted company within a predetermined period of time after listing, so that the company can indirectly gain listing status. What is special about SPAC is that it has no business operations and does not have any assets other than the proceeds from IPO and the funds raised by the sponsors of SPAC.

Photo: KPMG China

The operating Mechanism of SPAC

The SPAC mode usually consists of the following phases:

The first stage: SPAC listing stage

(sponsor), the sponsor of SPAC, is usually a private equity fund, financial institution or senior investor, and the sponsor sets up a SPAC company. The company is often a cash shell company with no actual business, and the sponsors acquire a certain proportion of the shares in the post-IPO SPAC company (usually 20 per cent in the US market) at a very low price. Because SPAC has no actual operating history, the financial statements are relatively simple, and the registration documents are almost formatted, so the production and submission of registration documents are relatively simple. Listing only needs to meet the lower listing threshold of the exchange, and it usually takes only 2-3 months to complete the listing.

After that, SPAC will raise money by issuing a typical $10 SPAC unit (Unit), which usually consists of a common stock (common share), and a full or partial warrants (warrant). The funds raised after the issue are usually placed in a special trust account (trust).

The second stage: looking for the target of M & A

After the listing of SPAC, SPAC sponsors need to use the raised funds to find and acquire M & A targets with operating entities within a specified period of time, and negotiate with the management of M & A targets on the terms of the M & A transaction. After listing, SPAC must find the M & A target and complete the M & A transaction within the specified time, otherwise SPAC will be wound up. The process of finding a suitable M & A target is similar to that of finding a target in a typical M & A transaction, that is, the sponsor examines the potential M & A target through due diligence in financial, tax, legal and other aspects. SPAC can not determine the M & A target in advance before listing, but the industry and region of the target company will be specified in the IPO specification. During this period, SPAC units can be traded on the open market, and investors can also choose to split SPAC units into corresponding shares and warrants to trade separately.

Phase III: M & A transactions or De-SPAC

De-SPAC is a key part of the process. After the SPAC promoters have identified the M & An objectives and successfully completed the negotiations, SPAC will enter into a letter of intent / terms statement on the terms of the SPAC M & An and seek approval from the board of directors of the SPAC and SPAC M & A targets on the relevant terms. Generally speaking, SPAC also needs to seek approval from the SPAC shareholder meeting for SPAC mergers and acquisitions.

If the SPAC merger and acquisition transaction is approved by SPAC shareholders, the company formed as a result of the transaction (the successor company) will become a listed issuer and replace the original SPAC, and trade on the secondary market with the new securities code and securities name. Generally speaking, the SPAC M & A transaction will make the owner of the SPAC M & A target become the controlling shareholder of the new issuer. SPAC shareholders can not only choose to convert SPAC shares into common shares of the inheriting company, but also choose to redeem their SPAC shares from trust accounts and get a certain proportion of cash and interest. If the merger and acquisition of SPAC is not successful at maturity, SPAC will need to be delisted and disbanded and return the funds raised to investors.

Source: HKEx, China International Capital Corporation Research Department

The Historical Evolution of SPAC

The listing mechanism of SPAC is not an innovative system that has existed in the past two years, and it originated in the 90s of last century. In the 1980s, "bad cheque" mergers and acquisitions led to a number of fraud allegations, so the U.S. Congress and the Securities and Exchange Commission ((United States Securities and Exchange Commission, "SEC") strengthened regulation of such companies and promulgated the Securities Enforcement Relief and American Stock Reform Act (Securities En-forcement Remedies and Penny Stock Reform Act)) and Rule 419 specified under the Act (Rule 419). In 1993, the American GKN company wanted to restore the market reputation of the "bad check" M & A company without being restricted by Rule 419, so it created the SPAC model and registered the "SPAC" trademark, that is, to establish a special "bad cheque" M & A company to pool funds in order to provide funds for M & An opportunities within a set time frame. SPAC does not belong to the definition of "bad cheque" M & A company in Rule 419, and at the same time it follows most of the investor protection measures stipulated by SEC.

Before 2010, companies such as Nasdaq and the American Stock Exchange required SPAC to carry out mergers and acquisitions only if a majority of shareholders voted. After 2010, Nasdaq applied to SEC to allow SPAC to make a buyback offer to investors after announcing its M & A target, so as to facilitate the sale of shares held by shareholders who do not agree to the M & A, and enable SPAC to carry out M & A without the support of the majority of shareholders. The American Stock Exchange also carried out this reform in 2011. Subsequently, a number of SPAC companies were listed on NASDAQ and American stock exchanges. The New York Stock Exchange made a similar reform in 2017, lowering the minimum number of shareholders in SPAC from 400 to 300, greatly increasing the attractiveness of the SPAC listing model.

The Toronto Stock Exchange of Canada ("Toronto Stock Exchange") also adopted rules to regulate SPAC in 2008, allowing SPAC, a special purpose acquisition company, to trade publicly. These SPAC companies raise funds to complete SPAC mergers and acquisitions and acquire unidentified potential targets of SPAC mergers and acquisitions. However, due to some practical problems and the rigid nature of these SPAC rules, it is less attractive for listed companies, financial people or institutions to initiate SPAC. It was not until April 2015 that the first real SPAC appeared in Canada.

The sudden novel coronavirus epidemic swept the world in 2020. Different from the real economy due to the weak growth of the novel coronavirus epidemic, the US capital market showed an abnormal prosperity in 2020. According to data released by SPAC Insider, a total of 248 SPAC were issued in the US market in 2020, more than four times the 59 issued in 2019, accounting for 53% of the total number of IPO in the United States that year, exceeding the number of traditional IPO for the first time. The reason may be: first, the SPAC mechanism itself has a redemption mechanism for investors, which is a low-risk investment tool; second, the listing of SPAC does not need a large-scale roadshow, which is conducive to the prevention and control of the epidemic, and it can also greatly improve the participation and activity of retail investors in the stock market under the background of epidemic and home quarantine; third, many investors with strong public influence have initiated the establishment of SPAC,. So that the SPAC model can be more widely recognized and concerned.

In the European market, London released SPAC, as early as 2000, but it has not been greatly developed because of its regulation of "suspension of trading as soon as acquisition". In order to maintain its status as an international financial center, the UK Financial Conduct Authority revised the SPAC rules on July 27th, 2021, no longer requiring SPAC to suspend its listing status when finding potential M & A targets, which also greatly enhanced the attractiveness of SPAC listing in the UK. In addition to the UK, Euronext in Amsterdam, the Netherlands, is also attracting investors' attention. In February 2018, the Dutch SPAC star company ONE became the first SPAC company on the pan-European stock exchange. In February 2020, CM.com, a global mobile service provider, went public through a merger with ONE. Pan-European Stock Exchange has previously launched a Pre-IPO project called "Tech Share" for technology companies. CM.com was the first batch of participants in 2015-2016. The successful listing through SPAC also provides a reference path for similar companies to follow the path of capital markets.

In the Asian market, South Korea and Malaysia introduced the SPAC listing mechanism as early as 2009. In 2021, Singapore and Hong Kong have also set up SPAC listing mechanisms.

In 2009, Korea Stock Exchange (KSE) became the first Asian exchange to introduce SPAC listing mechanism. Korean Stock Exchange defines SPAC as a company, whose sole purpose is to merge enterprises. After a successful IPO, the management team selects the target company, and then the shareholders' general meeting votes on whether to merge the target company, usually within 36 months after the completion of the IPO.

In the same year, the Malaysian Securities Commission developed a specific regulatory framework for SPAC, which was incorporated into the company law regulatory system. The guidelines stipulate that 90 per cent of the proceeds from SPAC should be held in the form of trusts. It is worth noting that although Malaysia and South Korea have introduced SPAC, as early as 2009, but the creation and trading is not active, many of them have been liquidated.

On September 2, 2021, the Singapore Exchange (SGX) officially issued the SPAC main board listing rules, which came into effect the next day. Some of the provisions of the new rules are much looser than those in the previous draft: the market capitalization of SPAC listed on the SGX is no less than S $150 million, lower than the S $300m in the draft; the minimum number of public holdings of SPAC is reduced to 300, below the 500 in the draft; and SPAC may not be based in Singapore, which previously required it to be based in Singapore.

The Hong Kong SPAC system was officially confirmed in December 2021 and implemented on January 1, 2022. Hong Kong's SPAC listing system is more stringent than that of the United States and Singapore, and it is also known as the "strictest SPAC system in history". We will also make a detailed interpretation of the Hong Kong SPAC system in the future.

Advantages and disadvantages of SPAC listing Mode

Compared with traditional IPO and other listing models, SPAC listing model has certain advantages for SPAC sponsors, investors and target companies.

From the perspective of SPAC sponsors, the advantages of this model are as follows:

(1) more convenient and lower cost than traditional IPO

First, the time to market through SPAC is shorter than that of traditional IPO. Compared with the traditional IPO listing takes 1-2 years, the SPAC model because the SPAC shell company itself has no actual operation business, the business risk factors are small, usually only 2-3 months to complete the listing.

Second, the SPAC model greatly reduces the cost of listing. Under the traditional IPO model, underwriter fees usually account for 5% of the total IPO offering revenue of listed companies. But in SPAC IPO, the amount of capital that SPAC sponsors need to invest is usually 2% of the total funds raised by IPO plus US $2 million.

Third, SPAC mode financing is more convenient. In addition to the initial IPO public fundraising, third-party investors (Private Investment Public Equity, "PIPE") can also be introduced to refinance during the De-SPAC phase, and financing from the open market can continue after the De-SPAC transaction.

(2) it is beneficial for SPAC promoters to choose high-quality targets.

SPAC sponsors can enhance the value of SPAC and its own investment value by choosing high-quality M & A targets, and De-SPAC transactions are usually in the form of reverse takeover, and SPAC companies can usually find larger target companies to achieve M & An after IPO.

(3) SPAC sponsors have a better chance of making considerable profits.

Sponsors usually subscribe for shares in SPAC at a symbolically lower price. After the completion of the merger and acquisition with the target company, the shares held by the sponsors will be automatically converted into the common shares of the target company, and the sponsors will get considerable profits.

From the perspective of investors, the SPAC model has better investment income protection, investment security and investment flexibility, as follows:

(1) the income from investment is guaranteed.

As SPAC is already a listed company before M & A, it only needs both parties to complete the necessary approval process, and its listing certainty is higher. And the sponsor of SPAC is usually a very professional investment and management team, under the protection of the professional team, the benefits of investors are often more secure.

(2) High security of investment

Before the success of the De-SPAC transaction, the investors' investment money is specially deposited in the trust account until the merger and acquisition. Before that, the SPAC sponsors can not use the funds, and their investment is more secure. At the same time, compared with other investment vehicles, SPAC will be subject to strict supervision by SEC, the New York Stock Exchange or NASDAQ and other financial regulators after listing, with open and transparent information and standard corporate governance, which is relatively more safe and reliable.

(3) more flexibility in investment

For investors, the SPAC model has a redemption mechanism, which is relatively more flexible and can better protect the security of the investment principal. If the De-SPAC transaction is not successful, investors can recover most of the investment money from the trust account; if the De-SPAC transaction is successful, investors can choose to dispose of their shares and retain warrants to achieve flexible arbitrage.

From the point of view of the target company, the advantages of this model are as follows:

(I) the valuation is more certain

In traditional IPO, company valuation is determined through investor meetings, roadshows, previous rounds of financing and previous similar offerings, which is easily affected by the issuance window and market fluctuations at that time. In the SPAC model, the target company can negotiate with the SPAC sponsors to determine the valuation, so it can get a more flexible and definite valuation, and the valuation is relatively less affected by market fluctuations.

(2) No risk of litigation or liability

SPAC is a newly established company with no actual business, and there is no risk of litigation, debt, operation and so on. In addition, the controlling shareholders of the target company do not have to pay a lot of "shell" fees, which is also the main advantage of SPAC listing over shell listing.

(3) the right of control shall not be impaired

In the traditional equity financing, investors usually ask for priority to restrict the control of the controlling shareholders of the target company, which weakens the discourse right of the original controlling shareholders of the target company. In the SPAC model, SPAC is already a listed company, and investors invest in SPAC. If SPAC merges with the target company, if there is no other agreement, it will eventually be converted into the common stock of the inherited company, and the controlling shares of the target company will not be weakened and diluted. In addition, the target company can negotiate directly with the sponsors on many aspects of the transaction, thus having more control.

(4) strong confidentiality

In the traditional IPO, when a company submits a listing registration report, it needs to disclose the corresponding information to the public. If the subsequent issuance is not completed, the information will remain in the public domain. In the SPAC model, only after SPAC and the target company reach an agreement, do they need to disclose information to the public, which is relatively more confidential.

SPAC has many advantages, but it also has some disadvantages, including the following points:

(1) imbalance of interests between sponsors and investors

Sponsors usually acquire about 20 per cent of SPAC at a lower price, so regardless of the outcome of the acquisition, and even if the share price falls after the merger, the sponsors can still reap economic benefits. However, for the target company, this means expensive equity loss, which may make SPAC listing more expensive than traditional IPO.

(2) the quality of the target company is uncertain

Because SPAC has no actual commercial operation when it goes public, it does not need to disclose the company's potential risks, historical operating performance and other in-depth information like the traditional IPO, so it is more likely to lead to misinformation or even fraud. In addition, the SPAC listing mode is usually faster and simpler than the traditional IPO, and the SPAC sponsors need to complete the acquisition within a specified time, otherwise they will enter the liquidation stage. This may also cause the sponsors to act hastily, resulting in the poor quality of the selected target company, which will also harm the interests of investors.

(3) dilution effect of promoters' shares

The promoters' shares will dilute the shares of other shareholders after dilution. SPAC sponsors usually get 20 per cent of the shares at a nominal price, and these shares do not need to provide additional capital when converted into common shares, so after the M & A deal, the sponsors' shares dilute the interests of other shareholders to a certain extent, resulting in dilution of the value of common shares held by other investors. In addition, the execution of warrants (including initiator warrants and SPAC warrants) may also dilute the shares of other shareholders.

Development status of Global SPAC Market

No matter in terms of quantity or scale, the United States is undoubtedly the hottest SPAC listing market in the world. IPO fundraising according to, SPAC Insider SPAC rose from $13.6 billion in 2019 to $83.4 billion in 2020 and to $162.39 billion in 2021 (as of December 31).

Correspondingly, the number of new SPAC shares has also risen, with 59 SPAC issued in the US market in 2019 and soaring to 248in 2020, nearly 4.2 times the number of IPOs issued in 2019. Although regulation has been strengthened since March 2021, the popularity of SPAC in the United States has not abated.

As of December 30, 2021, the number of SPAC IPO in the United States has reached 613, accounting for 48% of the total number of IPO in the United States.

Compared with the hot US market, the rest of the market accounts for a relatively small proportion of SPAC issuance.

In the European market, according to the "Investor safeguards for Special purpose acquisitions: recommendations for amending the listing rules" issued by the UK Financial Conduct Authority, only two SPAC new shares were listed in the UK and other European exchanges in 2020. But by the first half of 2021, two and 15 SPAC shares had been listed in the UK and elsewhere in Europe, respectively. Although there are far fewer SPAC shares in Europe than in the US, some European investment banks say they expect more than 30 SPAC listings in Europe and the UK in the second half of 2021.

Although there are not many countries with SPAC rules in the Asian market, Asian investors are increasingly interested in SPAC new shares. According to Dealogic, the number of SPAC shares issued by SPAC sponsors in Asia has increased from zero in 2016 to eight in 2020, when these SPAC raised a total of US $1.5 billion in 2020. At the same time, more and more SPAC listed in the United States are looking for SPAC M & A targets in Asia.

(the number of SPAC IPO over the years, the total amount of financing and the average amount of individual financing. Source: SPAC Insider,2021/12/31)

Conclusion

SPAC, which originated in the United States in the 1990s, was born to reshape the market reputation of "bad cheques" M & A companies and get rid of the shackles of Rule 419. with the continuous optimization of SPAC rules and the reform of the global production and life style under the epidemic of novel coronavirus, the listing mode of SPAC is full of vitality in the main capital markets of North America, Europe and Asia. It is not difficult to foresee that SPAC will attract more market attention in the future, and more and more companies will log on to the major global capital markets through SPAC. In addition to technology companies, it does not rule out the possibility that some mining companies will try to list at a lower cost and with higher efficiency through the SPAC model. We hope that through the introduction of the SPAC model, we can provide some help and reference for Chinese investors and Chinese companies, especially Chinese mining companies with mineral projects overseas.