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Shareholder activists who are searching for undervalued or underperforming companies could find an exceptionally target-rich environment among the SPACs that completed M&A deals in the last few years. But successful SPACtivism, as it’s now called, won’t be as easy as it looks on the surface. Nothing worth doing is ever that easy.
In 2021 alone, a record number of SPACs – more than 300 according to one study – completed de-SPAC transactions. Sadly, the value-creation record of these companies is disappointing to say the least. A report by Market Realist noted that 58% of the SPACs that completed mergers last year were trading below the SPAC IPO price of $10 at the end of 2021 – including many trading significantly lower. That list of underperformers will likely grow in today’s volatile market, providing fertile hunting ground for activists.
This week, SPACtivism is likely to be a big topic of conversation at the storied M&A and shareholder activism conference – Tulane University’s 34th Annual Corporate Law Institute – which attracts the leading lights of M&A and securities law to New Orleans. So, in the spirit of the Big Easy, I note that while SPACtivists may be ready to “Let the good times roll,” they may face some obstacles in mounting a successful campaign against an undervalued SPAC.
SPACtivism Wave Gathers Momentum
We are just starting to see evidence of a gathering wave of activism that may engulf de-SPACed companies. Last week, hedge fund Third Point, LLC, led by living legend Dan Loeb, called for a sale of Cano Health Inc., whose shares recently traded at a 40% discount to their August 2020 offering price. Third Point argues that Cano needs to explore strategic alternatives to address the gap between its share price and intrinsic value, and noted that investors have, “a largely unfavorable view of companies taken public through special purpose acquisition vehicles.”
Third Point’s push may be one of the first instances of a prominent activist investor targeting a SPAC – but it won’t be the last. In addition to depressed share prices, SPACs have other features that may draw the attention of activists. It’s important to remember: companies that went public through a SPAC merger are very new to the public markets and didn’t go through the typical underwriting process that comes with an IPO. That difference alone could leave both their managements and boards unprepared for an activist approach, although the problems may be greater than just a lack of underwriter diligence.
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Specifically, the corporate governance of a typical SPAC is especially vulnerable to criticism. A recent study notes that since SPAC sponsors usually hold significant stakes in the company, as well as seats on the board, there can be an inherent conflict between their interests and those of public shareholders. Activists could also seek to challenge typical aspects of SPAC governance structure, including dual classes of shares and staggered boards. Further, many SPAC boards still include members held over from pre-merger days, who may be criticized for not having the relevant experience needed to oversee the acquired business in its current form.
Advice to Activists: It’s Not as Easy as It Looks
While a SPAC’s lackluster valuation and sub-optimal governance structure may attract activists, it is far from certain that a campaign will succeed. The very same governance elements that leave SPACs open to criticism – such as dual classes of stock and staggered boards – also offer considerable protection in a potential proxy fight. And, the tendency of sponsors to retain large positions in the stock may make it difficult for an activist to prevail in a vote.
For activist investors, the most important consideration will be to articulate in detail to voters how your proposals, such as refreshing the board to add members with more relevant backgrounds, or pressing for a review of strategic alternatives, will correct the SPACs’ valuation gap. Since the sponsors may have enough shares to out-vote you, it will be important to put forward an in-depth strategy that can win over other shareholders to your cause.
A careful consideration and understanding of the shareholder base of the company is extremely important before pursuing a campaign. Shares held in retail hands can present a challenge in terms of getting owners to vote. Big index investors, including Blackrock, State Street and Vanguard, will enter de-SPACed companies, and understanding how they may vote will be important. Here’s a helpful hint: these investors really care about governance as well as environmental and social issues!
Advice to SPACs: You’re Not as Protected as You Think
While a SPAC’s board and management may take some comfort in their governance structure and heavy sponsor-ownership, they must recognize that there are potential chinks in their armor. Sponsors do not have infinite patience, and (if contractually allowed) may be tempted to sell their shares if the stock were to rise in response to an activist campaign.
Similarly, a sponsor, or a private equity-backer that still owns a large stake, may be inclined to support a potential sale of the business. Presenting a united front, in which management, sponsors and the rest of the board are closely aligned on the “right” strategy for the company, may make the SPAC less vulnerable to an activist’s entreaties.
It is also important to identify other weaknesses that might be exploited by an activist. As noted above, many de-SPACed companies still have hold-over directors who were part of the original SPAC board, and whose backgrounds do not reflect the acquired business. Sometimes even the operating management of a company, put in place by the sponsor, can lack the necessary experience to move the business forward and realize its value.
One study by a sell-side research firm found that, “… the biggest make-or-break factor of a SPAC’s stock performance post-merger was the sponsor’s related experience to the acquired company, or lack thereof.” The study also noted that, one year post-merger, SPACs with experienced operators saw a 73% average increase in valuation, while those lacking veteran operators suffered a 14% loss of valuation on average. Taking the initiative to refresh the board and/or management – before an activist threatens to do it for you – may be a prudent line of defense.
For activists seeking to communicate their approach to value-creation – or boards hoping to retain shareholder support – the assistance of proxy solicitation firms, investment bankers and legal advisors may help provide an informed perspective on the SPAC’s shareholder base, governance structure, and factors affecting valuation.
New Orleans author John Kennedy Toole, who achieved posthumous fame with his superb novel, A Confederacy Of Dunces, wrote: “I suspect that we are teetering on the edge of the abyss.” Similarly, many de-SPACed companies may be teetering on the edge of the abyss of an activist campaign. It behooves both the companies and their activist pursuers to have soundly analyzed and well-articulated value-creation strategies if they hope to sway the votes of shareholders.