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$300 Million to Burn, With a Catch

Here’s an odd predicament: You have to spend $300 million in the next 14 days or it all goes poof.

That’s what’s facing Michael S. Gross, a co-founder of the big private equity firm Apollo Management and a director of Saks. And a similar conundrum could be in store for a string of other big-name gamblers on Wall Street: Ronald O. Perelman, Bruce Wasserstein and Nelson Peltz, among them.

Mr. Gross, a 46-year-old entrepreneur with a penchant for shoot-for-the-moon risk, is one of dozens of deal makers who have recently piled into an obscure corner of Wall Street — one of the few places amid the market decline where money is still gushing in. If you haven’t heard about this little netherworld, you will: it is called — and please don’t let your eyes glaze over this alphabet soup of an acronym — SPACs, short for Special Purpose Acquisition Companies. In the 1990’s, a variation on the same idea was called a “blank check company.”

Think of it is as a publicly traded buyout fund — or perhaps, more accurately, poor man’s private equity. Average Joes finally get access to Masters of the Universe, at least that’s the sales pitch. Mr. Perelman, Mr. Wasserstein and Mr. Peltz have all started their own SPACs or are in the process of doing so.

Here’s how it works: Average Joe buys shares in an initial public offering for an investment company with no assets to speak of other than the pot of money from the I.P.O. The company’s sole mandate is to make one big acquisition. Average Joe has no idea what it will buy. And frankly, neither do the folks running the investment company. It’s a blind bet that the Masters of the Universe will live up to their name.

Of course, there’s a catch (there is always a catch), and here’s where Mr. Gross enters the picture: These investment companies have only 18 months to 24 months to find something to buy with all the money they raised and get shareholders to sign off on the acquisition. If the investment company can’t find an acquisition, it must dissolve itself and give back the money to shareholders, less the costs it incurred on its failed hunting expedition for a takeover target. (Not a bad insurance policy.)

Mr. Gross started a SPAC called Marathon Acquisitions and raised $300 million in the summer of 2006. Take a look at the calendar: his 18 months are almost up. Starting today, he’s got exactly 14 days left; that’s only 10 business days (but who’s counting).

Maybe he was diddling for too long, but whatever the case, he hasn’t found anything to buy — at least he hasn’t said so publicly. (He’s been hinting to friends that he might pull a rabbit out of his hat at the 11th hour.) Mr. Gross, who declined to comment, was at one point so desperate to buy something — anything — he told bankers on Wall Street and his friends that he was prepared to offer a $15 million reward to find a successful acquisition target. For him, not only will his chance of a big deal fall apart, he’ll be out about $5.5 million of his own cash he put into the deal (unlike regular shareholders, principals don’t get their money back).

And therein may lie the ultimate problem with this new tool of capitalism: the incentives to do a deal are pretty perverse. As a result, companies that have no business being public may soon be getting ticker symbols.

The way people like Mr. Gross get paid is by making sure they can get a deal across the finish line — not necessarily how great an investment it turns out to be five years later. If Mr. Gross can persuade shareholders to give the deal the thumbs up, he gets — are you sitting down? — 20 percent of the entire company. That’s a lot more than the 20 percent of the profits that private equity players take for at least ostensibly improving a company. And all he has to do is hold onto his shares for six months to a year after the deal is complete before he’s free to dump his shares.

Actually, it used to be a lot worse. In the 1990’s, blank check companies were involved in a series of frauds where shareholders were taken to the cleaners while entrepreneurs ran off with their money. The Securities and Exchange Commission got involved. Other blank check companies worked initially, but then went bankrupt. Jon Ledecky, who is behind one of the most successful recent SPACs — the acquisition of American Apparel — and has two more coming, presided over several deal-oriented companies he put together in the mid-1990s; all ended up in bankruptcy after he had left the companies and mostly cashed out. Now, he has reinvented himself as the SPAC King.

Today at least, shareholders, especially those that get in at the beginning, have a fighting chance. Hedge funds have been plowing into SPACs because they see it as a free option at a potentially great deal. If the investment company buys something that shareholders think is a dud, they can vote against it and get their money — which is put in an escrow account — back with interest. Heads you win, tails — well, at least you don’t lose. Most of the risk is borne by the principals in the deal like Mr. Perelman or Mr. Peltz. They have to put their money, name and time into the investment company and can’t get it out if they can’t complete a deal.

Last year, there were 66 initial public offerings for SPACs, raising a total of $12 billion, according to Dealogic. The biggest one ever was just completed, a company called Liberty Acquisition Holdings, which raised $1.03 billion. Its Master of the Universe is Nicolas Berggruen, a billionaire investor. He just finished another successful SPAC, Freedom Acquisition Holdings, which bought GLG Partners, a hedge fund manager. Its stock is up. Others haven’t been as lucky. If you got in early to Services Acquisition Corporation, which bought Jamba Juice, you did well. If you stuck around, you’re not a fan of SPACs. It’s stock price is down 60.5 percent since the I.P.O., to $2.76 a share; its shares traded as high as $12.25.

While early shareholders may be protected, it is the long-term investor, and a company that maybe shouldn’t be public, that may end up being the sucker. Most hedge funds jump into SPACs in the very beginning and sell immediately once the deal is completed, pocketing the difference. Whom do they sell their shares to? Average Joe. Once again, the big money makes out no matter what.

The timing of all these SPACs may be telling: with the market in turmoil, promoters say they should have a good chance of picking up distressed assets that would have gone to private equity firms — and maybe buy some businesses from private equity themselves. Some call them the next version of private equity. It’s even possible some SPACs could end up buying entire private equity firms, allowing firms that wanted to follow in Blackstone Group’s footsteps to become public through the back door even though the I.P.O. window closed on them. They might even buy other public companies.

Of course, virtually every bank is trying to get in on the action: Citigroup, Credit Suisse, UBS, Deutsche Bank, Lehman Brothers and Merrill Lynch to name a few.

But take note, one bank, so far, has refused to play the SPAC game: Goldman Sachs. Hmmm. Maybe that should tell you something.