Companies are increasingly going public by merging with Special Purpose Acquisition Companies (SPACs), which are publicly traded pools of capital formed for the sole purpose of merging with an operating company.

1. V O LU M E 2 0 | N U M B E R 3 | S U MMER 2 0 0 8
Journal of
APPLIED CORPORATE FINANCE
A MO RG A N S TA N L E Y P U B L I C AT I O N
In This Issue: Private Equity and Public Equity
Private Equity, Corporate Governance, and the Karen H. Wruck, Ohio State University
8
Reinvention of the Market for Corporate Control
Corporate Cash Policy and How to Manage it Amy Dittmar, University of Michigan
22
with Stock Repurchases
The Rise of Accelerated Seasoned Equity Underwritings Bernardo Bortolotti, Università di Torino,
35
William Megginson, University of Oklahoma, and
Scott B. Smart, Indiana University
Re-equitizing Corporate Balance Sheets: Jason Draho, Morgan Stanley
58
Choosing Among the Alternatives
SPACs: An Alternative Way to Access the Public Markets Robert Berger, Lazard
68
Competition and Cooperation among Exchanges: Thomas J. Chemmanur and Jie He, Boston College,
76
Effects on Corporate Cross-Listing Decisions and Listing Standards and Paolo Fulghieri, University of North Carolina
Callable Bonds: Better Value Than Advertised? Andrew Kalotay, Andrew Kalotay Associates
91
BIG Writing: The Fundamental Discipline of Business Writing Michael Sheldon, XMedia Communications, and
100
Janice Willett, University of Rochester

2. SPACs: An Alternative Way to Access the Public Markets
by Robert Berger, Lazard*
I
t has been widely reported that the U.S. IPO Through privately negotiated, tailored transactions, SPACs
market has been struggling of late. But here is can provide companies with access to the public markets in
a lesser-known fact: 67 operating companies ways that a traditional IPO often cannot. SPAC mergers
have entered the U.S. public markets since the typically exhibit some of the following characteristics:
beginning of 2007 without doing a traditional IPO.1 While • Complicated circumstances that are not suitable for a
corporate spin-offs account for a portion of this total, compa- traditional IPO;
nies are increasingly going public by executing reverse mergers • Readily available cash that facilitates a capital structure
into Special Purpose Acquisition Companies, commonly solution;
known as SPACs. (For a breakdown of how companies have • Specialized SPAC management teams that add exper-
accessed the public markets, see Figure 1.) Something of a tise that is difficult to replicate;
hybrid between an IPO and an M&A transaction, SPACs • Collaborative transaction structures that align the
now feature prominently in corporate discussions of strate- target’s interests with the public shareholders’;
gic options. • Solutions for target companies in sectors that lack
SPACs are publicly traded pools of capital that have research coverage and have few or no comparable companies
been raised for the sole purpose of merging with an operat- to benchmark the target’s valuation; and
ing company. They are formed and managed by individuals • Exit opportunities where there are no strategic buyers
or organizations with a track record of generating attrac- for the target company.
tive returns for investors. SPACs have been around since We will later examine three completed SPAC mergers
the 1990s but have traditionally been confined to pursu- to illustrate how SPACs can offer an alternative way for a
ing “below the radar screen” transactions. However, today’s company to access the public markets.
SPACs are routinely entering into significant transactions,
Who is Behind the SPACs?
such as Freedom Acquisition Holding’s $4.1 billion merger
with hedge fund GLG Partners2 and Aldabra 2 Acquisi- SPAC sponsors tend to have demonstrated a track record of
tion Corp’s $1.6 billion merger with paper and packaging success and a proprietary edge, which gives investors confidence
company Boise Inc.3 that they can source and execute a value-creating transaction.
What is causing this surge of SPAC mergers? As reported SPAC sponsors generally fall into one of four categories:
in Figure 2, nearly three-quarters of the close to $22 billion of Accomplished Operating Executives. Successful operating
capital raised by SPACs since 2003 has been raised since the executives who want to pursue acquisitions in their area of
beginning of 2007. Given that SPACs have a limited life—in industry expertise often raise SPACs. The SPAC gives them
most cases, two years—they aggressively pursue acquisition independence as well as potential financial rewards that are
targets. SPACs have grown significantly in size in recent years usually greater than they can expect as an operating partner at
(as can be seen in Figure 3), so they are now chasing bigger a private equity fund. Examples of such executives are Richard
and bigger targets. In addition, market forces are pushing J. Heckmann, Chairman and CEO of Heckmann Corp, who
targets towards SPACs. The “traditional” IPO market has previously ran K2 Inc., U.S. Filter and Tower Scientific, and
been slow in 2008, with only 35 IPOs having been priced Michael P. Connors, Chairman and CEO of Information
through July 31 (as compared to 137 in the same period a Services Group, who previously led VNU’s Media Measure-
year ago).4 And private equity firms, voracious acquirers over ment and Information Group and A.C. Nielsen.
the last five years, have been hobbled by the difficulties in the Unfunded Financial Sponsors. SPACs are often raised by
high yield and leveraged loan markets. dealmakers with vast networks of contacts that have developed
* Special thanks to Noh-Joon Choo for his contributions to this article. 11, 2007 and Factset as of November 2, 2007.
1. Source: Dealogic ECM Analytics, Dealogic M&A Analytics, Thomson SDC as of July 3. Source: Boise Inc. 8-K filing, dated February 29, 2008
31, 2008. 4. Source: Dealogic ECM Analytics as of July 31, 2006. Excludes IPOs of closed-end
2. Source: Freedom Acquisition Holdings Definitive Proxy Statement, dated October funds and SPACs.
68 Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008

3. How Companies Are Accessing the U.S. Public Markets
Figure 1
0.4% 0.8%
100
300 4.8% 9.3%
8.9% 10.0%
1
8.0%
26 21.8%
7.5%
24 2 27.5%
12 21
25
20
75
Number of Deals
14.5%
200
Number of Deals
50
246 90.8%
234 89.2% 87.3%
224 219 83.3%
33
100
72.5%
63.6%
12 25
87 8
35
0
2003 2004 2005 2006 2007 2008 YTD
(a) 0
Spin-Offs Closed SPAC Mergers
IPOs 2003 2004 2005 2006 2007 2008 YTD
IPOs Closed SPAC Mergers
Spin-Offs
(a) Excludes spin-off IPOs.
Source: Thomson SDC, Dealogic ECM Analytics and Dealogic M&A Analytics as of July 31, 2008.
IPO data excludes SPACs and closed-end funds.
SPAC IPO Issuance
Figure 2
15,000
75
66
# of Deals
SPAC IPO Volume
12,000
60
Volume ($mm)
9,000
45
37
$7,418
28
6,000
30
15
11
3,000 $4,641 15
2007
$3,380 $3,754
YTD
1 $2,115
$474
0
0
$24
2003 2004 2005 2006 2007 2008 YTD
Source: Dealogic ECM Analytics as of July 31, 2008.
track records of putting together good transactions and funding mandate. These funds typically have third-party capital
them deal-by-deal. The SPAC appeals to this type of sponsor but maintain a natural boundary between the fund and the
because it gives the sponsor dedicated capital and removes the SPAC. For example, hedge funds typically focus on liquid
hassle of finding co-investors for each deal. One such example investments in public securities and form a SPAC to focus
is Thomas O. Hicks, Chairman and CEO of Hicks Acquisition on control purchases of private companies. SPACs extend
Co. I, who personally funds his investments through Hicks the alternative asset manager’s franchise by leveraging the
Holdings. Another example is Nathan Leight and Jason Weiss, infrastructure built up to support the fund. Examples of
Chairman and CEO, respectively, of Aldabra 1 and Aldabra such alternative asset managers are Trian Acquisition I Corp,
2 Acquisition Corp, who founded Terrapin Partners, a multi- which is sponsored by Nelson Peltz’s Trian Partners, the
product asset management firm with a private equity business activist fund, and GSC Acquisition Co, which is sponsored
funded with the co-founders own capital. by GSC Group, an alternative asset manager with $22
Alternative Asset Managers. Alternative asset managers billion under management focused on credit-based alterna-
tive investment strategies.5
sponsor SPACs as a vehicle to execute control transactions
and capture opportunities that do not fit the fund’s core Corporates. Public companies have used SPACs as a vehicle
5. Source: GSC Group website.
Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008 69

4. Average SPAC Size
Figure 3
Size ($mm)
300
$250
250
200 $183
150
$91
100
$76
$43
50
$24
0
2003 2004 2005 2006 2007 2008 YTD
Source: Dealogic ECM Analytics as of 7/31/08.
to capitalize on deal flow that is outside of the company’s core an acquisition.
focus but might have some strategic relevance for the public Investors award the sponsors 20% of the equity that is
company. An example of this type is Navios Maritime Acqui- raised in the IPO (the sponsors’ “promote”) for a nominal
sition Corp., sponsored by Navios Maritime Holdings, a dry price. However, this is not a free ride for the sponsors. In the
bulk shipper, which raised a SPAC to pursue acquisitions of event the SPAC fails to close an acquisition, both the “at risk”
other types of ships, such as tankers or containerships. Several warrants described below and the sponsors’ promote become
investment banks, notably those without dedicated private worthless. Furthermore, unlike a private equity fund, SPAC
equity funds, have also raised SPACs to capitalize on the deal sponsors are not permitted to draw salaries and do not receive
flow that is resident within the advisory business. a management fee on the funds raised.
Although SPAC structures vary somewhat from deal to
How SPACs Work deal, all SPACs include the following governance features to
SPACs operate under the SEC’s “blank check” rules, which protect investors:
allow an issuer to raise money without disclosing informa- IPO Proceeds Placed in Trust. The net proceeds from
tion about its target. Accordingly, every SPAC prospectus the IPO are placed in a trust. The SPAC sponsors do not
must state that the sponsors do not have an acquisition have access to the trust funds until shareholders approve the
under consideration and have not had any conversations with merger. If a merger is not consummated, the trust liquidates
anyone about a potential transaction. The SPAC raises money and distributes the cash to the public shareholders. Since
in a traditional underwritten IPO, much like an operating the trust is typically funded with 98-100% of the gross IPO
company. Once the SPAC receives the money, it begins its proceeds and the trust earns interest over time, shareholders
acquisition hunt. When the SPAC finds its target company, will likely get all or slightly more than their initial investment
it announces the deal to the market and files a proxy state- back if the SPAC fails to close a merger.
ment with the SEC to solicit a shareholder vote. The SPAC “At Risk” Investment by Sponsors. The sponsor buys
closes the transaction after it receives shareholder approval, warrants in a private placement immediately prior to the
at which time the target merges into the SPAC and becomes IPO and places the proceeds into the trust. If the trust liqui-
a publicly traded company. dates, the proceeds from the warrants are distributed to public
Investors fund the SPAC by buying units, which usually shareholders and the sponsor loses its investment. This “at
consist of one share of common stock and one in-the-money risk” investment, which usually amounts to around 3% of the
warrant. A typical unit costs $10 and the embedded warrant proceeds raised in the IPO, aligns the interests of the SPAC
has a strike price of $7.00 or $7.50. Each share of common sponsors with those of its investors.
stock carries one voting right, while the warrant does not. Shareholder Approval. The SPAC must submit its acquisi-
The warrants will become worthless if the SPAC fails to close tion candidate to a shareholder vote. The SPAC is required
70 Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008

5. to send investors a proxy statement that has extensive disclo- IPO on December 15, 2005 to pursue an acquisition in either
sure about its acquisition target. If more than a pre-specified the business services, marketing services, consumer services,
percentage of shareholders (usually 30-40%) vote “no” and healthcare services, or distribution services sectors. In the IPO
exercise their conversion rights, as described below, the trans- prospectus, Mr. Watson and Mr. Ledecky stated that, among
action fails to close. their qualifications, they had formed 25 companies that made
Conversion Rights. Common stockholders who vote “no” over 400 acquisitions during their careers.
have the right to convert their shares into their pro rata share According to Endeavor’s proxy statement, Endeavor
of the proceeds in trust. identified and reviewed more than 100 acquisition opportu-
Limited Life. Most SPACs have a two-year life. If it does nities that fit its acquisition criteria, including demonstrated
not receive approval for an acquisition, the SPAC liquidates revenue growth, compelling growth prospects, attractive
the trust on behalf of the public shareholders. Extensions are current or potential profit margins, talented management
not permitted without shareholder approval. with an interest in continuing at the company, reasonable
Independent Board. SPACs typically construct a board of valuation expectations, ability to deploy capital productively,
directors composed of a majority of independent members. a willingness to operate as a publicly-traded company, and an
The audit committee is composed solely of independent direc- understanding of Endeavor’s structure, acquisition process,
tors. No cash is paid to directors, although most typically and timing.
receive a portion of the sponsors’ promote. Slightly more than one year after its IPO, Endeavor
Liquidity for Public Shareholders. Unlike a private equity announced that it had signed a definitive merger agreement
fund, public shareholders can trade their securities in the with American Apparel, a vertically integrated manufacturer,
market. The units, common stock, and warrants are all listed distributor, and retailer of branded fashion basic apparel based
and freely tradable on an exchange. in Los Angeles. The transaction closed in December 2007.
Lock-ups on Sponsors’ Securities. The SPAC sponsors’ Dov Charney, American Apparel’s founder, remains chief
securities are locked up until after the acquisition closes. In executive officer. Mr. Charney received approximately 37.3
most cases, their promote is locked up for six months to a million shares of Endeavor common stock, valued at $582
million at the closing of the transaction,7 which represented
year beyond closing. Their warrants often carry a lock-up as
well, although it is typically shorter than the lock-up on the 65.2% of Endeavor’s common stock outstanding. Endeavor’s
promote shares. cash was used to pay down debt, fund American Apparel’s
For the investor, SPACs are an attractive investment store expansion, and effect the buyout of Sang Ho Lim, Mr.
with limited, if any, downside and unlimited upside from Charney’s partner, on behalf of Mr. Charney.
the IPO until the closing of a merger. The majority of inves- Why didn’t Mr. Charney take American Apparel public
tors in SPACs are hedge funds that require liquidity for all through a traditional IPO?
of their investments and therefore do not have the ability to Capital Structure Solution. American Apparel’s highly lever-
invest in a private equity fund as a limited partner. Through aged capital structure threatened to restrain its growth. According
SPACs, they can create a customized portfolio of securities to the proxy statement, American Apparel would likely have
with private equity-like exposure with the benefit of liquidity been required to scale back its expansion plans if Endeavor failed
and the right to vote on the proposed acquisition. to receive approval for the transaction. Furthermore, American
Investors can trade the units or unbundle the unit into Apparel was in non-compliance with its financing agreements
its components. This flexibility allows investors to create for failing to satisfy its minimum EBITDA test for 2006 as well
different investment profiles, depending on their tolerance as its minimum EBITDA test and maximum senior debt to
for risk. Some investors are biased towards the common stock, EBITDA ratio test for the first quarter of 2007. Although the
which has the protection of the trust. Other investors prefer Company replaced its revolving credit facility with a revolver
to hold a diversified portfolio of warrants, betting that the from a new bank in July 2007, it needed to get waivers for
significant upside from the winners will outweigh the losers further violations of its covenants in September and October
that return zero. 2007. The potential for financial distress would likely have
complicated a traditional IPO process. The fact that American
Apparel had a negotiated deal with the promise of receiving
Case Study: Endeavor Acquisition Corp’s Acquisition Endeavor’s cash in the near future likely prevented American
of American Apparel6 Apparel from falling into financial distress.
Endeavor Acquisition Corp (“Endeavor”), a SPAC led by Eric Complicated Circumstances Not Suitable for a Traditional
Watson and Jonathan Ledecky, raised $129 million in its IPO. Several risk factors in the proxy statement might have
6. Source: Endeavor Acquisition Corp IPO prospectus, dated December 16, 2005, 7. Source: Factset. Price as of December 12, 2007.
and Definitive Proxy Statement, dated November 28, 2007.
Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008 71

6. complicated an IPO process. At the closing of the acquisition, According to Aldabra’s proxy statement, the sponsors
approximately 8 million of Mr. Charney’s Endeavor shares identified and reviewed more than 150 acquisition oppor-
were placed in escrow to fund the payment of indemnifica- tunities, entered into confidentiality agreements with 95
tion claims that may be made by Endeavor as a result of candidates, made non-binding written merger proposals to
breaches of American Apparel’s covenants, representations 12 companies and pulled out of two accepted merger propos-
and warranties in the Acquisition Agreement, and certain als because of due diligence issues.
lawsuits against the company. At the time of closing, Ameri- In June 2006, Aldabra announced that it had signed
can Apparel was defending two personnel-related claims and a definitive merger agreement with Great Lakes Dredge
was being audited by Federal and State agencies with regards & Dock (“Great Lakes”), the largest provider of dredg-
to sales and income taxes for previous years. ing services in the U.S. The transaction closed in January
Collaborative Transaction Structure. Since Mr. Charney 2007. Douglas Mackey remained president and chief execu-
did not take any cash in the transaction and would continue tive officer of Great Lakes upon the closing of the merger.
to own 65% of the company after the merger, he had a signifi- Madison Dearborn received 26.6 million shares of Aldabra’s
cant incentive to make sure that the deal was priced properly common stock, valued at $179 million at the close of the
transaction,10 and owned 66.5% of the company. Aldabra’s
for Endeavor’s public shareholders. Given that his common
stock would be locked up for three years following the close of shareholders owned 28%, with the remaining 5% held by
the merger, investors could assume that Mr. Charney believed Great Lakes’ management team. All of Aldabra’s cash was
that the stock price would be higher in the future. used to pay down a portion of Great Lakes’ bank debt.
Furthermore, the Endeavor transaction provided Mr. There were several reasons why Madison Dearborn
Charney with a clever way to finance the buyout of his found a merger with Aldabra to be more appealing than a
partner, Mr. Lim, for $67.8 million. At the time of the traditional IPO.
announcement of the merger, Endeavor agreed to buy out Complicated Circumstances Not Suitable for a Tradi-
Mr. Lim for cash and deduct 7.7 million Endeavor shares tional IPO. In Aldabra’s proxy statement, they described the
from Mr. Charney’s consideration in the event that Mr. dredging market as being “in a state of disorder unlike the
Charney could not effect the buyout himself. Since the industry has seen over the past ten years or more.” Why?
market reacted so positively to the merger, Endeavor later Most of Great Lakes’ dredging contracts are obtained
agreed to buy out Mr. Lim for cash without deducting any through competitive bidding processes with government
shares from Mr. Charney. By pricing the transaction attrac- entities, the largest of which is the Army Corps of Engineers.
tively for Endeavor’s shareholders, Mr. Charney effectively In the second half of 2003 and first half of 2004, U.S.
obtained his partner’s equity at no cost. domestic dredging bid activity declined due to budget-
Despite the complicated nature of the deal, it has been a ary pressures given the state of the Federal deficit and the
big success for Endeavor’s shareholders. At the time of closing, diversion of funds to support the war in Iraq. In addition,
investors who bought units for $8.00 in the IPO had securi- the Army Corps underwent an administrative reorganiza-
ties worth $25.00, a return of 213% over two years.8 tion that delayed its ability to request and receive funding.
As a result of these funding issues, the dredging industry’s
fleet was underutilized throughout 2004, leading to intense
Case Study: Aldabra Acquisition Corp’s Acquisition of pricing pressure for dredging work in 2004 and 2005. While
Great Lakes Dredge & Dock9 dredging projects were merely deferred, not cancelled, the
Aldabra Acquisition Corp (“Aldabra”), a SPAC led by Nathan funding issues would likely have marred the growth story
Leight and Jason Weiss, raised $55 million in its IPO on that is required in a traditional IPO.
February 18, 2005 to acquire a portfolio company of a private Lack of Strategic Buyers. Since Great Lakes already had
equity firm. Mr. Leight and Mr. Weiss demonstrated to inves- a 40% market share in the U.S. dredging market, it was
tors that their private equity firm, Terrapin Partners, had unlikely that a strategic buyer could merge with Great Lakes
a strong record of identifying profitable investment oppor- without anti-trust issues. Furthermore, Great Lakes operates
tunities by capitalizing on big-picture investment themes, under the protection of the Jones Act, which requires vessels
including changing socioeconomic and demographic trends engaged in dredging in the navigable waters of the U.S. to be
or underexploited intellectual property or proprietary busi- owned and controlled by U.S. citizens, to be manned by U.S.
ness practices. crews and to be built in the U.S. This effectively prohibits
8. Source: Endeavor Acquisition Corp IPO prospectus, dated December 16, 2005 and 10. Source: Factset. Based on stock price as of January 4, 2007.
Factset as of December 12, 2007.
9. Source: Aldabra Acquisition Corp IPO prospectus, dated February 18, 2005, and
Definitive Proxy Statement, dated November 8, 2006.
72 Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008

7. a foreign investor from entering the U.S. dredging business. According to ISG’s proxy statement, the management
Finally, Madison Dearborn was the third consecutive private team compiled a database of over 200 information services
equity owner of the company, which was bought by Black- companies and prioritized businesses that generate revenue
stone in 1991, Citicorp Venture Capital in 1998 and Madison mostly through fees and subscription sales to businesses,
Dearborn in 2003. This is another indication of the lack of governments and other institutional clients or advertising
strategic buyers for the company. sales in information products distributed to businesses,
Capital Structure Solution. Great Lakes had restrictive governments and other institutional clients.
financial covenants in its credit agreements and bonding On April 24, 2007, just under three months after its
agreement due to its high level of leverage. In 2004, due IPO, ISG signed a definitive merger agreement with TPI,
to the problems in the dredging business, Great Lakes the leading provider of professional advisory services and
was forced to amend its covenants, at the cost of reduced proprietary data to major corporations to optimize their
capital spending limits and less borrowing availability. In business processes through offshoring, shared services, and
the third quarter of 2006, the company again amended its outsourcing. The transaction closed in November 2007. ISG
credit agreement in order to give it more working capital paid Monitor Clipper Partners and TPI’s other shareholders
flexibility. Aldabra’s cash allowed Great Lakes to regain the $230 million in cash plus warrants to purchase an additional
financial flexibility to build new dredges, make acquisitions five million ISG shares at an exercise price of $9.18 (a 14.8%
and pay dividends. Furthermore, they were able to execute premium to ISG’s IPO price of $8.00). Mr. Connors stayed
an attractive buyout of several vessel lease obligations at a on as Chairman and CEO of ISG and took over day-to-day
multiple of 3.2 times the free cash flow generated by the management of the merged company.
vessels. TPI was not looking to do a traditional IPO; they were
Collaborative Transaction Structure. Madison Dearborn actually looking to sell the company for cash. However, the
did not take any cash in the transaction and continued to own SPAC proved to be the best option for the company.
67% of the company after the merger. Madison Dearborn’s SPAC’s Management Expertise. The SPAC sponsors’
substantial ongoing equity stake provided validation of the complementary skill set and vision for TPI were key features
price paid by Aldabra. of this deal. Given the human capital intensity of TPI’s
Lack of Sector Coverage. The lack of coverage of the dredg- business, cultural issues and the retention of TPI’s top talent
ing sector would have made a traditional IPO less attractive were vital. Mr. Connors and his team presented a compelling
relative to other more widely followed sectors. There are no vision for TPI as an attractive platform for growth that could
comparable companies, no research analysts with sector thrive as a public company. The ISG team developed a value
expertise, and no institutional investors that follow the dredg- creation plan to reduce costs and improve productivity to
ing sector. Therefore, the valuation would have been more generate annualized savings of $8-12 million, which would
difficult to establish in this case than for an IPO in a more be reinvested into new products and services and expanded
widely followed sector. geographic reach. In addition, ISG identified potential
At the time of closing, investors who bought units for bolt-on acquisitions to consolidate their market position and
$6.00 in Aldabra’s IPO had securities worth $10.34, a return add complementary products.
of 72% in slightly less than two years.11 Collaborative Transaction Structure. Although Monitor
Clipper took a significant amount of cash in the transaction for
the benefit of its limited partners, TPI’s management retained
Case Study: Information Services Group’s substantial equity upside to the business. TPI’s founder,
Acquisition of TPI12 Dennis McGuire, and TPI’s management team agreed to
Information Services Group (“ISG”), a SPAC led by Michael re-invest 30% of their after-tax proceeds into ISG stock at the
Connors, raised $259 million in its IPO on February 1, close of the transaction to demonstrate their commitment to
2007 to pursue an acquisition in the information services the future success of the company. Furthermore, the warrants
sector. Mr. Connors and several of his team members worked that were given to the sellers provided an additional reward in
together at VNU’s Media Measurement and Information the future for good performance. For its part, ISG announced
Group, A.C. Nielsen and Dun & Bradstreet. Mr. Connors that it would repurchase up to $85 million of its common
raised the SPAC to buy a platform company which he could stock and/or warrants to return excess cash and stabilize the
grow into a $1 billion company via organic growth and bolt- market after the close of the transaction.
on acquisitions. At the time of closing, investors who bought units for
11. Source: Aldabra Acquisition Corp IPO prospectus, dated February 18, 2005 and 12. Source: Information Services Group IPO prospectus, dated February 1, 2007,
Factset as of January 4, 2007. and Definitive Proxy Statement, dated October 17, 2007.
Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008 73

8. Typical $200 Million SPAC Capitalization Table Impact of SPAC’s Dilution on
Table 4 Table 5
Transaction Multiple
(all figures in millions)
(all figures in millions)
# Shares
Cash and
20.0
Public Sharesa Cash
Stock
Acquisition
Sponsors’ Promote Shares 5.0 Acquisition
Total Basic Shares 25.0 Acquisition Price $200 $600
Public Warrants 20.0 Net income $20 $60
Warrantsb 6.0
Sponsors’ Acquisition Price / Net Income 10x 10x
Total Warrants 26.0
SPAC Size $200 $200
Dilutive Shares Attri=butable to a
6.5 31.5 31.5
Fully-diluted SPAC Shares
Warrantsa
0.0 40.0
New Shares Issuedb
Fully Diluted Shares Outstanding: 31.5
Fully-diluted Post-Merger Shares 31.5 71.5
Valuation “Drag”c 11.5
$315 $715
Fully-diluted Market Capb
Valuation “Drag” as % of Shares
57.5%
Sold to Public
Fully-diluted P/E 15.8x 11.9x
a. Assumes $10 units, 100% warrant coverage and $7.50 warrant strike price.
In-the-money warrants converted to shares using treasury method.
a. Assumes same SPAC structure as Table 4.
b. Assumes sponsor buys 6 million “at risk” warrants for $6 million.
b. Assumes $10 share price.
c. Number of dilutive shares attributable to warrants plus sponsors’ promote shares.
$8.00 in the IPO had securities worth $8.36, a return of Let’s consider another simple example where the $200
4.5% in ten months.13 million SPAC buys a target with $60 million of net income
for $600 million. The SPAC gives the target its $200 million
Challenges of Merging With a SPAC of cash plus $400 million of new SPAC shares. As in the case
Merging with a SPAC is not without risk. SPACs have several above, the target is valued at a P/E multiple of 10. However,
structural hurdles that the target must understand before the investor in the common stock in the public market buys
signing a definitive agreement. Once the deal is signed, there at a P/E multiple of 11.9 after the SPAC dilution. There-
is always a risk that the shareholders do not agree with the fore, SPACs tend to do larger deals that spread the valuation
transaction proposed by the sponsor. Some of the key chal- drag over a larger base. SPACs that attempt to do small deals
lenges are as follows: relative to its size often face difficulties at the shareholder
Dilution. Many negotiations between SPACs and target vote; of the 20 SPACs that liquidated, 17 attempted an acqui-
sition that was less than two times the SPAC’s size.14
companies break down over dilution. The SPAC is burdened
with two forms of dilution: the in-the-money warrants and Time to Close. The shareholder approval process typically
the sponsors’ promote. A rule of thumb is that a typical SPAC takes four to six months as the SPAC and the target prepare the
has approximately $58 million of valuation “drag” for every proxy statement, work through SEC comments, and mail the
$100 million it raises(illustrated in Table 4). To see how this final proxy to shareholders. In competitive situations, the SPAC
affects valuation multiples, let’s take a simple example where is at a disadvantage relative to corporate or private equity buyers.
a $200 million SPAC buys a target with $20 million of net The long timetable between announcement and approval
income for $200 million in cash. In such a case, as shown in exposes the deal to market risk. In volatile markets, there is a
Table 5, the target is valued at a P/E multiple of 10. However, risk that a deal that looks good at announcement may look less
the investor in the common stock in the public market, once attractive at the time of the vote. When the vote is in doubt, the
the SPAC’s dilution is considered, is actually buying the same sponsor may have to buy out “no” votes, forfeit a portion of the
company for a P/E multiple of 15.8. promote, or re-negotiate the consideration with the target.
13. Source: Information Services Group IPO prospectus, dated February 18, 2005 14. Source: Dealogic ECM Analytics and Dealogic M&A Analytics
and Factset as of November 16, 2007.
74 Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008

9. SPAC Success Rate
Table 6 All-Cash Transactions are Difficult. When a SPAC enters
into a transaction where the target’s shareholder is cashing
out, investors view the valuation with extra skepticism. The
All SPACs Since 2003
optics are challenging: if the price being offered is so attractive
that the target’s shareholders are selling out, then why should
53 deals
the SPAC’s investors think it is such a great deal for them to
34%
64 deals
40%
buy? Therefore, unless the SPAC brings something to the
table other than cash, as was the case in the ISG-TPI transac-
tion, an all-cash deal may be difficult to get approved.
Structure-Oriented Shareholder Base. Most SPAC investors
21 deals
20 deals 13%
are generalists that allocate capital to SPACs based principally
13%
on the structure. When the SPAC investor does not under-
Pending Approval
Closed Merger
stand or appreciate the value proposition, he will most likely
Liquidated Still Looking
look at the situation in simple terms: if the common stock
is below the trust price, he will vote “no” and elect to take
All SPAC Votes Since 2003
his pro rata share of the trust. Because of this dynamic, the
SPAC and the target’s management team have to spend time
20 deals
27%
to identify new investors that understand the fundamental
thesis. In cases where the SPAC cannot fully transition the
shareholder base to fundamental investors, the SPAC sponsors
may have to buy the common stock themselves from the “no”
53 deals
voters to secure shareholder approval.
73%
Conclusion
Closed Merger
Liquidated
SPACs have stepped out of obscurity into the limelight,
having raised nearly $16 billion since the beginning of 2007.15
The quality of SPAC sponsors continues to improve as the
Source: Company SEC filings. Data as of July 31, 2008.
substantial rewards for success draw in prominent sponsors
with impressive track records. At the same time, the owners of
High Hurdle for Shareholder Approval. All SPACs offer target companies, including the leading private equity firms,
their investors conversion rights, which allow them to vote are becoming more sophisticated about ways to use SPACs to
“no” and claim their pro rata share of the trust funds. If more accomplish their goals. Once seen as merely a way to go public
than a pre-specified percentage of shareholders exercise their in poor market conditions, SPACs are now recognized as a
conversion rights (usually between 30-40% of the public vehicle to effect highly structured, creative transactions that
shares), then the shareholder vote will fail. This high approval facilitate an alternative way to access the public markets in
threshold has proven to be challenging for some deals. As bull or bear markets. As with any emerging market, there will
reported in Table 6, 27% of the SPACs that have gone to a surely be bumps in the road. While the traditional IPO will
vote have been rejected. remain the favored way to access the capital markets, Special
“Winner’s Curse” in Auctions. SPACs are not ideally suited Purpose Acquisition Companies will continue to thrive as a
for auctions. If the SPAC is paying the highest price among solution for companies with special circumstances.
the bidders for a target, then the SPAC has probably not left
significant upside for its shareholders. SPACs tend to shy away robert berger is a Director at Lazard and advises SPACs on IPOs
from well-attended auctions and instead focus on proprietary and mergers and acquisitions.
transactions based on the relationships of its sponsors.
15. Source: Dealogic ECM Analytics as of July 31, 2008.
Journal of Applied Corporate Finance • Volume 20 Number 3 A Morgan Stanley Publication • Summer 2008 75

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