Friday Letter: Return of the SPAC

Some US private equity firms are reverting to an acquisition vehicle last seen before the financial crisis: the special purpose acquisition company. With sudden stock market uncertainty, will it last?

Blink and it could be 2005. Asset prices are high, debt is cheap and readily available, and private equity firms are being creative in executing their deals. Even the stock markets, until this week’s rollercoaster ride, had been riding high.

And in the US, even the special purpose acquisition company, SPAC for short, has made a comeback. This month, TPG Capital became the latest US private equity group to create one when it registered Pace Holdings with the Securities & Exchange Commission (SEC), an entity formed to list on Nasdaq and raise $400 million.

TPG is not alone in having dusted off this particular leaf in the pre-financial crisis playbook to capitalise on investor appetite. Veteran turnaround specialist Wilbur Ross launched his eponymous acquisition company in May 2014 and raised $500 million. 

More recently, Marc Lasry used Boulevard Acquisition, a SPAC he created a last year, to acquire Dow Chemical’s specialty chemicals unit Agrofresh for $879 million.

You would think private equity firms have enough of a challenge investing the capital received from LPs. TPG has just raised a $3 billion growth equity fund and, according to market sources, its new buyout offering is also making decent progress. Does it really need to raise even more money for a ‘blank cheque’ company on top?

‘Need’ might be too big a word, but SPACs are certainly nice to have when you’re looking to capitalise on interesting opportunities that may lie outside the parameters of your core investment strategy.

According to the SEC filing, the TPG vehicle will go after companies characterised by “inefficient capital allocation, over-levered capital structures, excessive cost structures or incomplete management teams” in underperforming technology, media or business service companies. 

It’s the kind of opportunity a well-oiled deal-sourcing machine like TPG’s will come across sooner or later, but which the firm’s existing funds can’t readily accommodate. So why not take advantage of keen demand for assets in the public markets and pursue an opportunistic investment through a SPAC?

LPs might say SPACs are going to be a distraction for managers. However, the fact they are back might also be a benefit in that they can be a viable exit route for funds in their portfolios: in March, private equity private equity sponsors Charlesbank Capital Partners and Leonard Green & Partners sold their investment in Mexican food restaurant chain Del Taco to Illinois SPAC Levy Holding for $500 million, rather than disposing of the business via trade sale, secondary buyout or IPO.

Sceptical LPs might also want to bear in mind that SPACS are not going to be around forever. The last time they proliferated was in the mid-2000s, but when the financial crisis took hold, they quickly fell by the wayside as investor interest tailed off and the market window in which they were created closed. This week’s burst of stock market volatility is a reminder that buoyant IPO markets have a lifespan.

For TPG and anyone else with similar aspirations, therefore, time is of the essence. SPACs typically must acquire a business within a 24-month period after raising capital or, if unsuccessful, dissolve and return the capital to their shareholders. 

When the next downturn comes, those shareholders are going to get antsy, and the blank cheque phenomenon will disappear once again.