Special purpose acquisition companies (SPACs)—shell companies that raise money through an IPO and then use that capital to combine with target companies through an M&A transaction that results in the target company going public—attracted record levels of investment in the US in 2020, as a series of high-profile sponsors adopted them to finance deals.
According to Dealogic, there were 249 SPAC IPOs in the US last year, raising an all-time high of US$82.7 billion. This was more than six times the US$13.5 billion raised by 59 SPACs in 2019 and this momentum has carried into 2021. As of January 29, Dealogic had already recorded US$24.8 billion in SPAC fundraising from 90 companies for 2021.
The spike is likely to boost M&A activity and leveraged loan issuance over the next two years, as SPACs are typically obligated to secure a deal within 24 months or return capital to investors. SPACs are also expected to open up opportunities for private equity (PE)-backed portfolio companies to exit.
Emergence of new SPAC sponsors
There has been a significant influx of new sponsors raising SPACs, which has supported the sharp rise in issuance. Investors have been attracted by high-profile Wall Street names, including respected hedge fund manager Bill Ackman, who secured US$4 billion for his SPAC.
Established PE firms, including Apollo Global Management, TPG Capital and Solamere Capital, have also raised capital through SPAC structures.
The emergence of new sponsors raising money using SPACs has in turn proven attractive for fast-growing businesses seeking alternatives to traditional public market listing processes. Sports betting company DraftKings and digital gambling technology producer SBTech, for example, opted for a merger backed by Diamond Eagle, a SPAC sponsored by Hollywood executives Harry Sloan and Jeff Sagansky, over other listing and financing options.
M&A issuance uplift is expected
According to Dealogic, there were 94 SPAC-based merger deals in the US in 2020, worth a total of US$153.3 billion—more than five times the US$27.7 billion in SPAC deals recorded in 2019. By January 29, there had already been 15 SPAC merger deals, worth US$32.9 billion, in 2021.
These deals are likely to have a positive impact on US M&A leveraged loan issuance, which was down 14% year-on-year in 2020, primarily as a result of COVID-19.
Under a traditional SPAC structure, there is no cap on the size of the company the SPAC is allowed to acquire and there is scope for a SPAC to raise financing for deals it pursues. In a number of cases, SPACs have combined with target companies valued at two-to-four times the SPAC’s IPO proceeds. This can be funded with debt or via private investments in public equities (PIPEs) with institutional investors (or a combination thereof).
A number of SPAC-backed businesses have gone on to secure leveraged loan funding on broadly market terms. Companies involved in SPAC transactions, including supply chain software business E2open and loan analytics platform Open Lending, for example, have been able to negotiate financing packages on covenant-lite terms, in a number of cases due to PE investors’ active involvement in the financing process. Leverage multiples for SPAC transactions, however, have tended to be more conservative than for PE deals.
Sponsors turn to SPACs to create exit opportunities and to cut their debt
Beyond the additional deal flow for leveraged loan lenders, SPACs also provide sponsors with an exit opportunity via public equity markets, and give companies an opportunity to reduce debt following a SPAC merger and then secure new financing packages on more flexible terms.
At the end of 2019, for example, a SPAC sponsored by Goldman Sachs and former Honeywell CEO David Cote invested the US$690 million it raised from investors for a 20% stake in Vertiv, a maker of cooling equipment for data centers, backed by Platinum Equity Partners. In March 2020, the company announced it had agreed to a US$2.2 billion term loan financing, which was used to refinance its previous term loan and redeem in full its high yield bonds. Vertiv CFO David Fallon said the refinancing, in conjunction with a significant paydown of debt using the proceeds from the SPAC deal, had resulted in material reductions to financing costs and given Vertiv greater financial flexibility.
Other PE firms in the US have adopted a similar playbook and agreed to deals with SPACs for portfolio companies, then used the proceeds of the transaction to pay down existing debt while retaining their holdings in the newly formed SPAC entity.
For example, Advantage Sales & Marketing, a marketing agency backed by PE firms CVC, Leonard Green & Partners and Bain Capital, merged with the Conyers Park II Acquisition SPAC in a deal valuing the business at approximately US$5.2 billion. Deal proceeds were used to refinance existing debt and Advantage’s existing PE backers rolled over their stakes into the new structure.
After closing the deal, Advantage took on new senior secured credit facilities, on cov-lite terms, comprised of a US$2.1 billion term loan facility and US$400 million asset-based revolving credit facility.
SPAC deals are not without obstacles, as they are subject to a shareholder vote which can prolong the process (or derail the process if the required shareholder vote is not obtained) and put the SPAC at a disadvantage as to execution when competing against other bidders for an asset. In addition, SPAC shareholders typically have the right to redeem their shares in connection with an acquisition, creating uncertainty as to the amount of cash proceeds available at closing. To address this risk, many SPAC acquisitions are structured with a concurrent PIPE.
The amount of capital SPACs have to invest and the valuations they have been prepared to meet, however, coupled with the scope for PE portfolio companies to use SPAC deals to pay down debt and create exit opportunities for their owners, suggest these structures are likely to play an important ongoing role in leveraged finance markets.