Top Street investment banks are stepping into territory thus far dominated by the minnows: specified purpose acquisition vehicles, or SPACs, which are essentially blank check companies. Deutsche Bank this month signed onto two vehicles--both related to real estate investing, Lehman Brothers is widely quoted as preparing an offering and other firms such as Citigroup are considering employing variations on the structure.
SPACs are run by management teams who raise cash with institutional investors and then go out in search of an acquisition. The money is put in escrow and acquisitions are voted on by shareholders. "The structure [takes] the private equity guys out as mediators," said one executive, adding the vehicles allow for private equity-like returns because investors are betting on the ability of a management team to go out and generate profits in sectors in which they are experts.
Deutsche Bank set up a deal for Grubb & Ellis, the real estate company which will use the SPAC as its asset management and property acquisition arm. The S-1 was filed Oct. 21. Earlier this month it also took over a vehicle called Cold Spring Capital run by Richard Stratton, a specialty finance and real estate investor who's done a number of deals related to time-shares and resorts. The two planned IPOs are the first to be filed by a bulge bracket firm following dozens of offerings this year run by smaller shops such as EarlyBird Capital and Morgan Joseph.
"The return characteristics [for investors] are much like a convertible bond," explained another capital markets executive. The shares and warrants issued by the vehicles trade on an exchange and don't usually fall far below their typical $6 issue price. SPAC IPOs have returned an average 29% over the last year and because the bulk of the principal sits in escrow, maximum downside is between 5-10%. Still, a recent survey suggests that overall, investors have yet to warm up to SPACs.
For the large investment banks, there's additional upside beyond the 7% underwriting fee. "It generates clients over the long term. If we pick the right firm, management will eventually need M&A advice, financing--we end up expanding our customer base," said a banker. Officials at Lehman didn't return calls by press time and Deutsche Bank and Citigroup officials declined to comment citing registration periods.
And while every investment bank, large or small, pledges that its management team is the best for the job, it remains to be seen whether SPACs will continue to perform. "These things are getting harder to do," said Sagiv Shiv, a managing director at Punk, Ziegel, a New York boutique. "They were fashionable for a while but most of them haven't found acquisitions yet." SPACs generally have 18 months to lock in a deal before they must return their money to investors. "With the M&A market heating up, multiples and premiums are rising and the good stuff is getting more expensive."