Let us begin with two important notes:
1) We really dislike SPACS. By design, the structure puts money in the hands of sponsors and third party advisors and generally leaves the merged company with an underfunded treasury and not much of a clue as to how to operate in the public arena. It is no surprise at all that most of those who chose what was pitched as an easier way to go public and completed their SPAC mergers are now swamp things, mired in single digit muck, left to flounder by an uninterested investment community.
2) We have no economic or other involvement with Pershing Square or anyone who works there.
With that out of the way, we do love helpful innovation.
On Friday 9/29 Pershing Square received SEC approval for a newly designed “son of SPAC” product called a SPARC. (https://www.sec.gov/Archives/edgar/data/1895582/000119312523247555/d305814d424b3.htm)
For a very small subset of very special companies with a particular goal for a public offering, we believe this structure is among the most company-friendly, investor rational process improvements to come around in a long time. (“Among” because for many, the hybrid auction structure still has enormous advantages but that’s a different column.)
From an investor perspective, the SPAC approach of “give us your money now, to invest in something or other over the next two years, and oh yes, you can have it back, possibly with some warrants if it doesn’t work out” is as clever as going to the track and putting it all on a jockey with no steed, or betting on the favorite at the Kentucky Derby. You might possibly get lucky and make a little money, but the risk/reward relationship makes little sense. Even if you do come out in the money, presumably those returns are certainly not what your fund investors, the ones paying your salaries, had in mind when they entrusted their capital to you. And in an environment where short term CDs pay ~5% and have close to zero associated risk, well, something about a bridge for sale comes to mind.
The SPARC structure is very different. Investors receive a right to buy shares at the same price as the sponsor, in this case funds from historically successful Pershing Square, once they know what the target company is. Rather than of holding their collective noses and jumping in, investors can actually see that the pool not only has water but that the temperature and chlorine levels are to their liking. Don’t like it? Don’t invest; the look cost you nothing. Do like it? Ok, see what the valuation looks like after a brief exploratory trading period and then make the call. Really like it? Buy just as you would on the open market with any new issue. Huge incremental knowledge shifts the balance of power to the investor.
From the perspective of the company to be acquired (CtbA) this structure also offers many pluses, albeit a few reasons to pause. Starting with the pluses: The (CtbA) receives a real, meaningful, (not less than $250M, up to $3.5B) not instantly redeemable, deposit in the treasury account. The size of the investment ensures that the investor (in this case Pershing) will have to care about the ongoing health of the company in the aftermarket as at that size, the position can’t easily be flipped. That's not Pershing's style anyway. With no sponsor “promote” and the time value of the due diligence required before the investment, a quick flip = a lousy ROI. Therefore, right from the start, the company has a key, committed, aligned, long-term investor not unlike what it would have with a strategic private placement. But wait, there’s more: the investment isn’t a private placement as other shares in the company will trade in the open market allowing both employees and other investors the full range of daily trading opportunities.
The other key element of the transaction is the price and on this, there are two perspectives. For some, avoiding the slings and arrows of daily market swings and bounces, and the comfort of locking in a price with a committed investor with other investor friends in high places, will likely be very, very appealing. Certainty can be really helpful as, for starters, knowing what will be in the treasury not only reduces stress but also can be super helpful to the budgeting process. On the other hand, some managements and boards may believe that market enthusiasm will result in a higher valuation; it’s risk/reward thing. Those believing the open market will pay more may choose to pass. As mentioned earlier, this structure is for certain companies with certain goals. Some may want certainty; some may want market pricing. The beauty is the company Pershing pursues will likely be savvy enough to have the option to decide either way.
There are numerous other details that make this structure worth a look for the few that qualify. We believe that SPARCs indeed solve almost all of the things we hate about SPACS, elements that honestly were problems for both issuers and public investors. Only the 3rd parties were winners in most cases. That said, the one challenge that remains with the SPARC structure is readiness. It is one thing to go public, via whatever structure. It is quite another to operate successfully as a public company. Too many looked at SPACs as a “get in the water fast” opportunity and then discovered that without having put in the effort to develop into strong swimmers, meaning thorough pre-listing preparation, it was a quick trip to the bottom of the pool. Pre-IPO prep is incredibly important, regardless of the listing approach. Everything from smoothing out the quarter close process, to installing the right planning systems, to fully explaining to employees what it means to be a public company and much more, will matter once public, regardless of listing approach.
Still, as long-time critics of SPACs and in many cases Direct Listings, which benefit third party sellers more than issuers, a SPARC strike us as a genuinely thoughtful, fair, wicked-clever innovation that merits a close look by the subset of issuers for which it was designed.
Hooray for Pareto Optimal innovation.
