SPACS and Shareholder Activism, Featuring Innisfree’s Jonathan Salzberger
ONE-ON-ONE: SPACS AND SHAREHOLDER ACTIVISM
Risk &Compliance Magazine: Reflecting on the last 12 months or so, could you provide an overview of interest and activity surrounding special purpose acquisition companies (SPACs)? What factors have caused this area of the market to experience an explosion of growth?
Jonathan Salzberger: Special purpose acquisition companies (SPACs) have become an integral part of the transactional menu for several reasons. Compared to traditional initial public offerings (IPOs), SPACs are viewed as providing greater certainty to target companies – targets know the approximate amount of cash they are going to get from the sponsor and private investment in public equity (PIPE) investors – and may allow younger, ‘pre-revenue’ companies to go public faster because they can provide projections to the market, unlike in an IPO. Sponsors also get the benefit of large stakes in the post-merger company in return for seeding the SPAC and executing the merger. Investors, in turn, receive warrants and the ability to redeem their stock at trust value, providing both downside protection and greater upside. These economics, combined with volatility in the traditional IPO and M&A markets, the ability to tap retail shareholder excitement for investment during the pandemic, and the increasing sophistication, and sometimes celebrity, of SPAC sponsors, have all led to a sharp spike in activity.
R&C: To what extent are SPACs, or their newly merged entities, being targeted by shareholder activists? What types of campaign are activists typically launching and what demands are driving them?
Salzberger: Generally, shareholder activism is difficult in the pre-merger SPAC because of the sponsor’s sizeable ownership and the ability to redeem the stock at trust value, setting an approximate floor on the price. That redemption pressure and the practical necessity of finding PIPE investors will also push sponsors to find decent targets, although we could see some pre-merger activism as SPACs chase a finite amount of potentially weaker assets as stronger assets are taken. Post-merger, however, these combined companies could be ripe for activism, both on the short and long side. Many have been valued at high multiples, especially because they were able to market themselves off optimistic projections, which they would not otherwise be able to do in a traditional IPO. They may have management teams inexperienced in the public markets and may also be in relatively early stages of development. These factors could lead to hedge funds publicly claiming that the shares are overvalued in the short term or that the shares could be worth much more if only the company changed strategy, governance or management teams in the long term.
R&C: How would you characterise the impact of the coronavirus (COVID-19) pandemic on shareholder activism?
Salzberger: The pandemic put activism largely on hold for most of 2020 – activists were hesitant to publicly target companies and companies were eager to settle so they could focus on steering their firms through the tumult. Activism has resurged as the economy has stabilised and any companies that underperform are more easily picked off as the stock market continues to climb. Activists also have a significant amount of pent-up dry powder that they need to deploy after sitting on the sidelines. Additionally, the SPAC market has introduced hundreds of new public companies through the pandemic, taking advantage of their unique economics and retail investor enthusiasm. This is a huge pool of potential activist candidates ready to be dissected.
R&C: Could you highlight any examples of high-profile activist campaigns against SPACs? What insights might we draw from their outcome?
Salzberger: DiamondPeak’s de-SPAC with Lordstown Motors, an electric truck start-up, may be the highest profile SPAC activism story. According to the press, the sponsor was eager to find a deal after a few missed opportunities and may not have done the necessary diligence, especially on the management team whose track record was spotty and whose chief executive officer (CEO) appeared prone to hyperbole. After the de-SPAC, a short seller, Hindenburg Research, accused the company of misleading investors about the capabilities of its electric pickup truck and making false statements regarding the number of pre-orders. Shortly thereafter, Lordstown’s CEO and chief financial officer (CFO) resigned following announced inaccuracies. The stock has fallen over 70 percent in the aftermath. This story reinforces the necessity of doing proper M&A-style diligence on the target and its management team, ensuring that the post-merger company has the credibility to withstand activist attacks, particularly in early-stage technology companies that often go public through a de-SPAC.
R&C: From the formation of the SPAC through to the de-SPAC transaction and beyond, what steps should boards and senior executives take to prepare for a potential activist campaign? Are there any common vulnerabilities that demand a defence strategy?
Salzberger: As with activism more generally, it is essential to be prepared. Companies should utilise a stock surveillance service to better understand their shareholder base and have a ‘break the glass’ plan in place. Ultimately, however, the best defence is good financial performance and credibility. That means while a target company will surely project an optimistic picture of its performance to the SPAC and the market, it must try to maintain credibility with its new investors. If not, the stock could be ripe for correction and without shareholder support. Credibility will also help these newly public companies attract and retain some of the PIPE and other longer-term investors in the stock to ward off potential activists. Governance must also be considered. While the governance community disdains dual class super-voting stock and classified boards, among other defences, many young companies have recently gone public with such structures. Companies should consult with their legal advisers, banks and proxy solicitors on the pros and cons of these strategies, both before the de-SPAC vote and beyond.
R&C: If a SPAC does find itself subject to an activist campaign, how should it respond? Are certain reactions likely to inflame rather than diffuse the situation?
Salzberger: Every situation is different, and companies should consult with their defence teams, including public relations (PR) firms, lawyers, bankers and proxy solicitors. Certain questions should be asked: What is the activist’s thesis? Has the board considered the actions demanded? Should they proactively enact some of the changes or otherwise better explain to the market, both publicly and in private engagement, why the actions taken by the company make sense for shareholder value? Is there an explainable disconnect in the value of the company ascribed by the market versus management? Are there governance changes that need to be made, perhaps appointing new directors with more extensive industry and public company experience? Credibility is paramount and the board needs to convey that its members have their ‘hands on the wheel’, understand and are already addressing the concerns being raised. It is rarely a good idea to ignore or otherwise directly attack the activist, which risks inflaming the activist, losing credibility with other shareholders, and putting further pressure on the stock.
R&C: To what extent has the proliferation of SPACs attracted the attention of regulators? What facets of SPACs are regulatory bodies most concerned about, and are activists picking up on these concerns?
Salzberger: SPACs are in the crosshairs of regulators. For some, SPAC mergers are seen as a regulatory end-run around the more robust vetting of traditional IPOs, where the only projections shared are the conservative or ‘haircut’ guidance provided to selected analysts to help build financial models. Underwriters also provide an additional layer of scrutiny to IPO candidates. SPACs, meanwhile, have safe harbours from liability for statements about the future and do not go through the same underwriting process. Some at the US Securities and Exchange Commission (SEC) and certain investor groups see no legitimate reason for this regulatory arbitrage and want to eliminate this safe harbour protection for de-SPACs, especially considering cases such as Lordstown Motors. Activists may not care about these perceived regulatory inconsistencies per se, but they will be paying attention to differences in valuation and to new, weaker entrants that only got to market because of this ‘short circuited’ process. They can claim that the vetting was inadequate and that projections provided were too rosy, that the management team is inexperienced or perhaps that the asset should not be public in the first place and should return to private equity hands. The potential attacks are plentiful.
R&C: In your opinion, what is the outlook for SPAC-related shareholder activism in the months and years ahead? How do you foresee battles playing out in this space?
Salzberger: 2020 and 2021 witnessed a huge pool of potentially immature companies brought to market that could create a surge of activism. Activists only have a finite number of public companies to target and SPACs have added new blood. And there are many more de-SPACs to come. As the most desirable targets are acquired, the clock will be ticking for those SPACs that have not found a partner and they may get desperate, chasing poorer assets. This will only lead to more activist attention down the line, but it will take time for this dynamic to play out. The immediate post-de-SPAC structure provides some natural defences; however, as shareholder bases normalise and insider lock-ups expire, activists will be ready to pounce on any mistake. Shareholder activism is not going anywhere, and activism at de-SPACed companies is likely to accelerate over the medium to long term.
Founded in 1997, Innisfree M&A Incorporated (New York), along with its wholly-owned subsidiary Lake Isle M&A Incorporated (London), is a high-stakes shareholder engagement firm, delivering shareholder intelligence, strategic advice and proxy solicitation services to the world’s leading corporations and investors when it matters most. Its integrated approach and unsurpassed analytics–ActiveIQ™–set Innisfree apart as the firm of choice. Innisfree provides expert advice on a wide range of matters, including shareholder activism, executive compensation proposals, corporate governance issues and investor relations.
With an experienced professional staff in New York, London, Pittsburgh and Richmond, VA, Innisfree has represented hundreds of clients in over 20 countries. www.innisfreema.com
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