Introduction to evaluating SPACs

In a way, the introduction of the Special Purpose Acquisition Companies (“SPAC”) to the investing public at large had created a stir in the Malaysian capital market. The SPAC, introduced in 2009, was greeted with mixed views and reactions, some extremely positives and some extremely negative; unlike when the Guidelines for "Business Trusts" were introduced a few months earlier. Some investors were saying that it is a good thing for the market and some are confused as to why did the regulators allowed such risky investment.


A check on the public traders' chat rooms, when the announcement of Hibiscus' pending IPO was made included statements like

““Crap” IPO coming”
“Looks like Bursa is becoming a gambling den”
“save your money to stock up your foods better”
“’salute’ to my dear bursa… company without core business also can list!..just make me sick!”
“u dare invets in tin milo kosong?” “I only worry that the tin milo will not be filled with tin milo but wit tepung gandum”
“Awesome”
“no core business, mesti kena PN17 Mah”
“BOYCOT IPO and keep away on listing day”
“This one, no job, just want free money from public”
“If SPAC can be listed, why not allow PN17 co go re-IPO, instead of delisting? L L L L L L”


However, Hibiscus persisted and it was listed in July 2011. And subsequent to the listing of Hibiscus, another two SPACs were announced ready for listing, but this time round, the tune of the trading platform was a bit different….very…. positive...

“This is definitely going to be growth stock”… “at least six months time horizon”
“A smaller version of Petronas”
“Another hibiscus >> $$”
“Another small baby of Oil and Gas player” “ Will there be a repeat of Hibiscus J J J J”
“prepare ur gun for it”
“Sona petroleum spac reference price …”… “attackkkkkk”
“SOLID JACKPOT”
“Sona petroleum simply the best $$”
“Golden opportunity”
“even magnum jackpot also cannot challenge”


And by the time we get to Reach Energy's SPAC, the comments started to sound greedy and envious (in my opinion lah) when we have comments like this "only chicken feed to the retailers". And if I am not mistaken there was an open letter written to the PM asking that more allocation for the SPAC shares be made for distribution by a certain group of remisiers (presumably because it is such a hot item, macam pisang goreng panas)


There were many reasons that could have caused this change in attitude and perception, and one of the could be better understanding of SPAC and its value…. Well really?... naah...:-) Honestly I do not think so.


I think the change in attitude was due to how the prices of the SPACs have behaved, in particular Hibiscus, and how the investors have benefited from it. But then, price is not the same as value; price may rely on value as one of its inputs but price are subjected by a host of other factors which includes expectations, demand, supply and liquidity.


Therefore, the evidences do show that SPAC has created a stir in the market, drawn reactions from the investors, but there was not much information to explain why. Nothing to state if any of the reactions, positive or otherwise, are justified. Let alone the price.


But before we proceed, I wish to make a HUGE DISCLAIMER, that everything that I write here are merely for discussion purpose and MUST NOT be relied upon for any investment decision. The idea is to give you the reader, a perspective from my point of view, from how I see it and then how I might try to evaluate and value the price of SPAC. I use real companies just to illustrate my points and ideas; no recommendation whatsoever on the companies in question. You, might agree or disagree with the methodology or the inputs (which I might use sample figures). But by reading on, you have agreed to use everything here for educational purpose only :-) and will not hold me responsible for your investment decision :-)


I will begin the discussion with a claim that the root cause of the ‘stir’ is lack of familiarity and knowledge of SPAC and with that the lack of ability to evaluate SPAC as an investment. It is a classic response to an unknown where the basic instinct of survival will kick in first, rejecting all unknown; the subsequent actions were short term reactions to what one saw from output of the unknown (in this case, the share price), and when one sees share price going up, the natural tendency is to be opportunistic and starts making up justifications to grab the opportunity, although the subject is still unknown and the basis for the price movement is a blank to them. Action (share price up) creates an immediate reaction in some (buy buy buy); had it gone down, it would have been the reverse regardless of the underlying value of the SPAC. They were knee jerk reactions.


If investing based on knee jerks is not our cup of tea, then we need to dig into the SPAC and find out what is the fundamental value of a SPAC. All investment has a value; it is a question of it being subjective and objective. And in order to understand the value of the SPAC, we need to understand the fundamentals of the SPAC. Understanding the fundamentals of the SPAC would also enable us the investors to evaluate the SPAC and ultimately assist us in making the right investment decision (including resource allocation). While it is true that price is not the same as value, but value will provide an anchor for the price, a reference point that is not purely due to market reactions. In the process of understanding the SPAC, we would also be able to find the answers to some of the reactions in the market.


And by the way, by now you may have guessed the I am one of those who they term as a fundamental investor.


The first thing I found out when I was doing my research on the subject matter is that, non-sophisticated investors could easily been confused with the nature of the SPAC. I discovered that there are many ways that the market have been describing SPAC, including SPAC as a Blind Fund / Private Equity, Ordinary Listed Company, Reverse Merger instrument, Composite investment. And save for the Ordinary Listed Company, none of the views of SPAC is a commonly known subject for the general retail investors, especially in an emerging market. But that does not mean that SPAC cannot be issued, it just mean that the investors are justified to be initially confused but need to improve their know-how if they want to invest in the SPAC.


In this series of blog write-ups, I have broke down the sections into the following, based on what I think a SPAC should be understood:

• SPAC Pre-IPO, which is broken down further into mini segments that discussed SPAC from the perspectives of a blind fund, a listed company and a composite investment;
• SPAC Post IPO but before the EGM. The EGM is a critical point to me as it marks the end of an embedded option that I believe existed within the SPAC shares.
• SPAC for EGM & completion of qualifying acquistion.

In my journey of discover with regards SPAC, which I will share here, I discovered that SPAC is not what we might be accustomed to believe, and that its investment characteristics changes as it progresses through its life: from not having an operation, to having an idea of an operation to actually having an operation. And to add on to the complexity of it all, I also discovered that there ordinary shares of a SPAC are that that ordinary after all which gives a SPAC an embedded option (which is not the warrant) inside the share itself; and hence the investment characteristics of the SPAC would also change as the embedded option expires at the EGM.


Anyway, let's begin the journey of understanding SPAC by looking at a SPAC before it is listed (pre-IPO). At this stage, we probably have a copy of the prospectus of a SPAC that detailed out the management of the company, their plan with what they wanted to do with the money they could raise from the IPO, the outlook of the industry.


However, one thing would immediately stick out glaringly: it does not have a business! This was something new and unusual to us, where we have been accustomed to thinking that there is a certain minimum level of operational risk that a regulator would have allow to be presented to the public investors via the stock market; and that is the existence of an operation. When we looked at the all the listing requirements, the element of having an operation is a common denominator for companies that are allowed to be listed in the Main Board, the ACE market, Mesdaq previously, Business Trust, REITS and even infrastructure project companies must have a 'secured' agreement relating to how they are going to generate revenue in place.


To further add to that was the fact that the regulators would eventually delist any companies that does not have any operation (commonly known as cash company), and the reason they were not delisted automatically upon losing the operation, is mainly due to the fact that there are public shareholders still holding the shares and every opportunity must be given for them to realize the listing premium. But the shareholders are there before the operation went missing, unlike SPAC which in a way getting an investor to invest in a 'technically' PN17 cash company. This state of confusion and apprehension would be the immediate reaction to the introduction of SPAC…how can they ??!

Click here for the next segment "SPAC as a blind (private equity) fund"