By Stephanie Jacob
Spacs are generally a high risk, high return sort of proposition. From the start investors buy in based on the strength of management and not guided by assets and solid financial track records. However, are there enough safeguards in the Spac model to protect the investing public, and more importantly are the public aware of just how risky the Spac game is?
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When the Securities Commission (SC) first introduced the concept of special purpose acquisition companies (Spacs) into the Malaysian financial scene, the reaction was mixed. The SC said that the idea behind bringing the model here was to “promote private equity activities, spur corporate transformation and encourage mergers and acquisitions to enhance the depth, breadth and competitiveness of the Malaysian capital market.”
Investors and market watchers however were not so sure, for one the concept of investing in a company that is a shell without assets and a financial history to study would go against the grain for most.
Secondly Spacs in the international arena have a varying record of success at best. In the United States, where the model is arguably the most used, Spacs have seemingly had more failures than successes.
In an unflattering piece on the model, the article in the Dealbook section of The New York Times questioned the sustainability of the model, highlighting that it is a thriving financial product despite a record of failure.
The article begins by saying that ”strange financial products sometimes exist not because they are good for investors or companies, but because they offer their promoters a way to profit,” and then going on to suggest that Spacs are an example to prove the statement.
Along with the seemingly unfair advantage promoters have over regular investors in terms of entry price; other concerns also includes who the burden of risk falls on, especially post acquisition.
Hadian Hashim
When you ask Hadian Hashim, managing director of Sona Petroleum if he thinks that it is fair that the management teams (who often are also the promoters) of Spacs receive salaries in the five figure region at minimum even before they have made an acquisition or generated revenue, he says yes.
For Hadian, it is all about the risk the promoters are taking. “ If we do not get a qualifying asset in time, an investor gets his money back but mine (investment) is completely burned. In the event we return the money to the investors, the promoters get zero.”
Therefore he says that if it works, everyone gains but if it does not then the promoters stand to lose the most as they are locked in by moratoriums. He says detractors need to look at the picture in totality and understand that it is in everyone’s best interest to secure a qualifying investment and for the company in general to succeed.
To an extent, Hadian has a point in that the SC has strict rules on QA’s and these do allow investors a fair degree of protection and say in determining if the QA being proposed is accepted or not.
Investors who are not happy with the QA being tabled, can ask for their money back or vote against in at the extraordinary general meeting that must be called by the management team. Should more than 20% of public shareholders vote against the proposal, then it should be aborted.
However that protection only lasts until a QA has been secured, after that shareholders become vulnerable again as now the asset has to produce results. The risk also very much shifts from the promoters to the public investors, due to the discrepancy of their share entry price.
Take Hibiscus for example, the first Spac to have acquired its QA to become a fully fledged oil and gas exploration and production company.
Promoters of the company such as Kenneth Pereira, Joyce Vasudevan and Pascal Hos along with the rest of the management team hold a 20% stake or slightly more than 55.57 million shares of Hibiscus Petroleum via Hibiscus Upstream.
Plus this together with the one-for-one free warrants, Hibiscus Upstream collectively holds 111.14 million shares and warrants, which they would have initially purchased for 1 sen each or about RM1.1 million. A public investor however would have come in at 75 sen per share, and for the same amount of shares would have had to pay over RM8.3 million.
So while the management team has managed to secure a satisfactory QA, they still are yet to produce results. Yet, should their first attempts to drill oil in Oman fail, the impact felt by the management team as opposed to the public investors are going to be remarkably uneven.
Furthermore with the moratorium that was placed on Hibiscus promoters and management team expired, there is realistically nothing to stop them from cashing out; besides their individual commitments to the company and the damage that will come to their reputations if they choose to bail from a sinking ship.
Learning from this the SC has worked to tighten the regulations placed on subsequent Spacs looking to list, and in particular on its management team post securing a QA. One way in which the SC has done this is by ensuring that the moratoriums in place have become stricter.
When Spacs had been first introduced the basic regulation was that the management team entire shareholdings would be locked from the point of listing up until a QA is secured. From then, the management would be able to move its stake at up to 50% per annum.
However Sona Petroleum the latest Spac to have listed on Bursa, has a much more stringent moratorium in place.
The Spac’s management team are not allowed to touch its shares up until the company generates one year of audited revenue from the commercial production of its QA. The SC also appears to be trying to balance out some of the risk by lowering the entry price for public investors from 75 sen for Hibiscus to 50 sen for Sona investors.
From this, it is perhaps safe to say that the SC is learning and fine tuning the Spac model as more ook to enter the market and that is a positive development.
Nonetheless, it will be equally important that alongside with tightening up the model and the expanding on the regulations that govern it, the SC also work to ensure that public investors know the enormous risks that come with investing in a Spac and are not just blinded with the possibility of massive gains.
As an analyst with a local bank backed research house says, “You are buying into the strength of management alone, that is extremely high risk already…Spac investors must be those with the appetite and capacity for a high risk, high return game.”
Everyone else should proceed with extreme caution.
Yesterday: Hibiscus faces its biggest test.
Tomorrow: Is there room for non-O&G Spacs?
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