58 Finance & economics The EconomistAugust 1st 2020
2Buttonwood The SPAC hack
I
n an episodeof “The Phil Silvers
Show”, a 1950s tvcomedy, Ernie Bilko
(played by Silvers) discovers that his
fellow army sergeants have fleeced a new
recruit in a poker game. His plan to get
the money back involves leasing a shop.
“It’s just an empty store,” he insists. The
others fear they are missing out. “When
the smartest operator in the whole Un-
ited States army suddenly decides to rent
a store, we don’t ask no questions,” says
one. “We just want to be cut in.”
An empty vessel can accommodate all
manner of dreams. This trait helps ex-
plain the growing allure of the “special
purpose acquisition company” (spac), a
shell company listed on the stock ex-
change with a view to merging it with a
real business. Ventures such as Virgin
Galactic, in space tourism, and Nikola, in
electric vehicles, have become listed
companies by this route. Silicon Valley’s
dream factory spies a way to sidestep the
trials of an initial public offering (ipo).
Bill Ackman, a shrewd hedge-fund man-
ager, has just raised a $4bn mega-spac.
He is looking for a unicorn to make a
home in his empty store.
The view in Silicon Valley is that an
ipo is a rotten process. There is typically
a fixed fee, of up to 7% of the sum raised.
And the value of the company is low-
balled, say tech types, to allow for a
satisfying first-day “pop” in the share
price. Yet cost is not the only bugbear—
and, perhaps, not even the main one.
What entrepreneurs and their venture-
capital backers hate about the ipois the
loss of control. They are used to being big
shots in Silicon Valley. They do not like
deferring to Wall Street types at all.
An ipois meant to be a young com-
pany’s coming of age. It can be more like
a funeral: a distressing ordeal that leaves
you at the mercy of those you put incharge of it. The problem lies with an
asymmetry. For the firm going public, the
ipois a one-off. But not for the underwrit-
ing banks. They have a relationship with
the people buying shares. It is natural for
them to favour repeat customers. The
bankers run the roadshow to build a book
for the ipo. They control the allocation of
shares. And crucially, they set the price. If
the ipogoes well, the banks retain the
right to issue more stock to “stabilise” the
market—a valuable option, known as a
greenshoe. This, complains a Silicon
Valley bigwig, is a “rapacious practice”.
Enter the spac, which is a sort of pre-
cooked ipo. A shell company is set up by a
sponsor. The spacis listed on the stock
exchange via an ipo. The sponsor then
finds a private business for the spacto
acquire with the proceeds. Typically this
will be a late-stage (ie, fairly mature) priv-
ate company, whose owners and venture-
capital backers are looking to cash out. The
private company merges with the spac,
following a shareholder vote. It is then a
public company.
You can see the appeal for Silicon Val-ley. There is no roadshow, no ploughing
through the same slide-deck ten times a
day for a fortnight. It all takes much less
time. That is handy in the present cir-
cumstances, when venture-capital firms
need to get cash-burning unicorns off
the books. Because this is a merger, and
not an ipo, the selling firm can disclose
more information to the buyer, includ-
ing financial projections. The price is
negotiated directly with the buyer—and
after the money has been raised, not
before. And it is all but certain, rather
than at the mercy of the changing moods
in the stockmarket, or a last-minute
discount imposed by the bankers to
sweeten the deal for favoured clients.
There is a downside, of course. Fees
are unavoidable. Sponsors are typically
paid with a 20% stake in the spac. This is
in essence an indirect charge on the
acquired firm. It is not obviously cheaper
than an ipo. In principle the sponsor can
dilute his effective “fee” by, for instance,
co-ordinating another round of capital-
raising from private-equity or hedge
funds at the time of the merger. A few
sponsors might inspire a halo effect,
increasing the share price just by associ-
ation. Investors will not question a really
big name; they just want to be cut in. And
the 20% fee is not set in stone. Mr Ack-
man, for instance, is taking a much
smaller cut and making it conditional on
reaching performance targets.
Trustworthy sponsors will keep their
own capital tied to the venture. But Bilko
is not to be trusted, of course—where
would the comedy be in that? His three
rival sergeants realise too late that he has
sold each of them a one-third stake in a
worthless venture. “Don’t you own a
piece of it?” asks one in a panic. “Me? I’m
in the army,” replies Bilko. “What would I
want with an empty store?”The latest twist in the power struggle between Silicon Valley and Wall Streetate lenders, reported that loans held under
moratorium had fallen from 30% in April
to under 20% in June; Kotak Mahindra re-
ported a fall from 26% to 10%. State-owned
banks are only beginning to release their
earnings, but their use of the moratorium
seems likely to have fallen too.
Analysts are now asking whether loans
and interest obligations will be fully repaid
once the moratorium ends. The rbi pre-
dicts that non-performing assets, as a
share of the total, could rise from 8.5% in
March to 12.5% in 2021. It reckons this
could exceed 16% for public-sector banksin a “severely stressed” scenario, which
would surely push some banks’ capital ra-
tios below regulatory requirements. Shak-
tikanta Das, the rbi’s governor, urged
banks to “proactively augment” capital
now, rather than waiting for shortfalls to be
revealed later. On July 27th Fitch, a rating
agency, was blunter, warning that “state
banks face solvency risk without fresh cap-
ital injections”.
How much capital is needed is unclear,
given the uncertainty over loan losses. In
April Prakhar Sharma, an analyst at Jeffer-
ies, an investment bank, put the fresh capi-tal needed by the public banks at 889bn ru-
pees ($12bn) and at half that for the private
lenders. Some banks are beginning to pre-
pare themselves: Kotak Mahindra raised
nearly $1bn in May;iciciplans to seek a
similar amount, as does the State Bank of
India, the country’s largest lender. But
many of India’s weaker banks, saddled
with legacy problems and uncertain loan
losses, are likely to attract scant interest
from investors. Much of the rbi’s early re-
sponse to the pandemic involved protect-
ing borrowers. It may yet find itself being
forced to step in to save some lenders. 7