Market SPACulation | China Enterprise Law Journal
Chinese companies have been at the forefront of the SPAC wave in the US, but geopolitics is pointing to a possible pivot to Asia. However, shifting market dynamics may be a spanner in the SPAC works. Freny Patel reports
The SPAC is trending strongly in China. The country stands to get a handsome share of US$1 trillion dollars of M&A activity in the two years following an estimated US$129 billion capital raising by special purpose acquisition companies (SPACs), a Goldman Sachs report from April says.
China has used SPACs as a gateway to the US, taking advantage of the opportunity to list more of its tech companies there, significant in itself given that half of the reported 600 unicorns worldwide are from China.
SPACs, a capital raising alternative to IPOs, have been around for decades, but gained popularity in 2020 due to the increased volatility in the capital market with the breakout of the pandemic. The surge was led by high-net-worth investors, sitting on enormous amounts of cash, who were attracted to invest in these shell companies, which were backed by big names that could attract other investors.
SPACs are shell companies that raise funds through IPOs to finance acquisitions, which through the “de-SPAC” process result in a reverse merger. This form of capital raising offers private businesses a fast track to go public, based on future projections.
Softbank’s CEO, Masayoshi Son, hedge fund manager Bill Ack-man, former economic adviser to US president Donald Trump, Gary Cohn, former Goldman Sachs banker Gerald Cardinale, and baseball executive Billy Beane are just some of the big names associated with SPACs who have raised billions from investors. SoftBank Group raised a US$280 million SPAC in March 2021, while Bill Ackman raised a US$4 billion SPAC in July 2020.
The list also includes leading Asian businessmen, the likes of property tycoon Li Ka-shing, former APAC Goldman Sachs president Kenneth Hitchner, Olympic gymnast Li Ning, among others, who are backing SPACs that are looking to acquire companies with a significant Chinese presence.
Many SPACs are reportedly eyeing Chinese targets or businesses with a presence in China. Primavera Capital Acquisition raised US$300 million in the US earlier this year, and is targeting a consumer business with a presence in China. Likewise, a Hony Capital-backed SPAC wants to merge with tech-enabled companies in healthcare and consumer products that have a significant China presence.
Most SPACs are listed in the US as most countries do not allow for SPAC listing because, more often than not, regulations do not permit the listing of shell companies.
US investors are increasingly familiarising themselves with Chinese listings because many American investment portfolios include several Chinese names and China-exposed businesses, says James Tunkey, chief operating officer of I-OnAsia, a global risk consultancy specialising in SPAC due diligence.
“SPACs present opportunities for US investors to gain new access to Chinese companies at different stages of their growth cycle, including companies that might typically be a part of a pri- vate equity portfolio,” Tunkey tells China Business Law Journal.
However, with the majority of SPACs listed in the US, the cur- rent frigid Sino-US relations could be a party spoiler and the coun- try’s home-grown unicorns may risk losing out – unless the tide turns and SPAC listings are allowed in Asia.
“Geopolitical risk has re-emerged as a real concern over the past few years, partly as a consequence of a recalibration by US voters on the value of trade with China,” says Tunkey. China-linked SPACs on the US and other foreign markets are susceptible to becoming victims to the current anti-China narrative, he adds.
Leading data and analytics company GlobalData forecast in its January 2021 report that Chinese companies could instead look to the east. Geopolitical developments challenge the future of some large Chinese companies listed in the US, and could force some Chinese tech, media, and telecom (TMT) companies to shy away from US exchanges in 2021. According to GlobalData, 25 Chinese TMTs completed their IPOs on US stock exchanges in 2020.
“The new Biden administration has not taken positions as out-spoken as those expressed by the previous US administration when it comes to Chinese companies listing in the US,” says Gerold Niggemann, a New York-based partner with Hughes Hubbard & Reed.
However, Tunkey says regulatory scrutiny is not the major factor that drives the choice of which market is the best fit for the business. There are a lot of other considerations. “There are lots of great reasons to come to the US, or go to Hong Kong, and we see London as a hot market in the near future,” he says.
There are certainly great opportunities, but what could spoil the party for Chinese-backed SPACs and their targets is that filings and disclosures by shell companies and their private targets have come under regulatory scrutiny.
The US Securities and Exchange Commission (SEC) has started taking a hard look at SPACs, and in April this year it issued guidance to companies on the accounting treatment of warrants, and the risk of forward-looking statements. The regulator has requested information from banks as it looks into the accounting treatment of the warrants that are typically being issued to IPO investors when a SPAC first raises funds.
Niggemann says that the SEC’s actions affect the balance sheets of companies that went public through a SPAC. “It will be interesting to see how the market reacts,” he says, because when it comes to a tech startup, for many investors the balance sheet of the startup may not be the most important factor in making their investment decision.
Tunkey cautions the need for good risk management and compliance systems, saying diligence has a major role to play in the de-SPAC process. “We see the US and Chinese regulators both committed to ensuring healthy capital markets,” he says, adding that due diligence has just as significant a role to play in China as it does in the US.
Tunkey says investors and regulators are concerned about the quality of revenue disclosures, and when de-SPACs involve operating companies that have less of a verified track record when it comes to revenues, some additional diligence may be warranted.
Most SPACs are, by their nature, very new and fresh, and this means limited investments in people, processes and systems that would otherwise have reduced the risk of key management engaging in improper business practices or insider trading.
While the regulatory environment is changing rapidly, Linklaters’ Hong Kong-based partner, Lin Xiaoxi, hopes US laws will not change in a manner that completely prevents the SPAC structure. “There are benefits offered by a SPAC structure that can be preserved with proper regulations,” he reasons.
The SEC has in the past scrutinised some Chinese companies for falsifying their accounts, one such example being China Energy Savings Technology. Its auditing firm settled with the SEC, but was barred from accepting any assignments from Chinese firms.
The writing on the wall is apparent. China’s three telecoms companies lost their appeal against the New York Stock Exchange’s (NYSE) 6 January announcement to delist. The NYSE moved to delist China Telecom, China Unicom and China Mobile, following the investment ban imposed by the US president Donald Trump.
Asia eyes SPAC listings
Listing overseas has in the past been associated with “a certificate of quality”, and this was seen as important internationally for Chinese companies, for which the quality of financial reporting has often been questioned.
Leading Asian capital markets such as Hong Kong, Japan and Singapore are accelerating their efforts to grab a piece of the action by allowing the listing of SPACs. Chinese companies have attracted maximum interest, and China is likely to gain once SPAC listings take off in Asia.
As the US takes a hard stance against Chinese investment and threatens to delist, some companies would favour listing in other overseas markets, preferably in the East, and more likely in Hong Kong or Singapore, lawyers say.
“The continued frigid Sino-US relations means that investors and targets are looking for a more geopolitically neutral venue,” says Stefanie Yuen Thio, joint managing partner at TSMP Law Corporation, based in Singapore.
This gives Singapore “a small window to grab market share”, as Chinese money and Chinese targets – including foreign businesses with largely mainland-based business operations – need a geopolitically neutral marketplace, she explains. “But we have to do it quickly because the [SPAC] frenzy may not last long,” she adds.
Singapore has sought public feedback on its proposed SPAC listing framework, but Thio points out: “Singapore needs to provide an alternative forum for SPAC listings, not a whole different framework.”
Singapore has proposed listing criteria of S$300 million (US$225.3 million) for SPACs, with up to three years for blank-cheque companies to combine with a target.
Hong Kong’s Securities and Futures Commission (SFC), and Hong Kong Exchanges and Clearing (HKEX), are exploring the option of SPAC listings to improve the city’s competitiveness and fundraising capabilities.
Japan and India are also vying to get into the game and have started consultation with the industry.
Niggemann is of the view that the US will not lose to other Asian markets because the US capital markets seem to have “pole position”. Investors will look for a favourable and reliable regulatory environment, with a deep pool of capital and experienced advisers, he explains.
Linklaters, with its strong capital market practice in Asia, is looking at the various stock exchanges that have started consultation on an Asian version of SPAC, says the firm’s Asia head of capital market and incoming regional managing partner, William Liu.
Confident that “Asia will be able to pick up the flow”, Liu points to the depth of the market, citing Hong Kong, where the law firm has facilitated the US$10 billion secondary listings of Chinese food delivery giant Meituan.
Liu says Asian markets will be able to pick up quite a bit of the flow because the cost in Asia will be lower than the listing of a SPAC in the US. This will help startups in Asia. “We are very keen to see that happening in Asia,” he says. “If we put [in] the effort together and the rule changes, all that can happen this year.”
Not so SPACtacular
SPACs raised close to US$100 billion in public offerings in 2020, which is more than the combined amount raised in the decade prior, according to S&P Global. But has the SPAC bubble frozen since the explosive first quarter of 2021?
March 2021 alone saw SPAC IPOs raise US$34.5 billion. But the amount raised in April fell to US$3.7 billion, the lowest figure in 10 months, according to Refinitiv, a global provider of financial market data.
The deal volumes have collapsed on Wall Street after the Securities and Exchange Commission (SEC) questioned the accounting principles of SPACs.
The SEC even issued a warning to investors to avoid investing in SPACs based solely on celebrities, after a surge of investments in SPACs came from the backing of celebrities like tennis player Serena Williams and rap star Jay-Z.
Amid growing concerns that the SPAC bubble will burst, the SEC is issuing public warnings and closely scrutinising deal filings as it tries to rein in deals. Meanwhile, many SPACs being wildly overvalued bring about a fear that some of the targets are trying to evade regulatory scrutiny.
The once flourishing SPAC market will have to rethink its strategy. Many SPACs might need to refile financial statements after the SEC’s guidance on accounting for warrants as a liability, and not equity, on financial statements.
The SEC’s corporate finance unit acting director, John Coates, warns of “some significant and yet undiscovered issues” prevailing with SPACs. In a tweet, the SEC quoted Coates: “The rapid increase in the volume of SPACs represents a significant change, and we are taking a hard look at the disclosures and other structural issues surrounding SPACs.”
But it is not just the SEC’s April guidance on the accounting treatment of warrants and the risk of forward-looking statements that has led SPAC mania to lose its momentum.
The plunging stock prices of de-SPACed companies on Wall Street, with several trading below the IPO price of US$10 per share, has further fuelled a massive drop in SPAC interest. Class-action lawsuits alleging false and misleading statements against SPAC transactions have also fuelled the fall.
It may well be the nature of SPACs. Unlike an IPO, SPACs do not have any operating business, hence their IPO process has limited disclosure. The key in fund-raising lies with the experience and expertise of the SPAC management, and not their financial reports. Since SPACs do not necessarily have any targets in mind, there are limited target-related disclosures made when listing.
“Any simple claim about reduced liability exposure for SPAC participants is over-stated at best, and potentially seriously misleading at worst,” says Coates.
SEC investigations are primarily against de-SPAC companies for painting eye-popping forecasts that belie the reality. But then again, SPACs eye targets in futuristic industries, such as space exploration, self-driving cars and electric vehicles.
Several companies in the electric vehicle space face lawsuits. Other futuristic industries are under SEC scrutiny for their misleading financials. Recently, online sports betting operator DraftKings and spaceflight firm Virgin Galactic Holdings said they would “fix accounting mistakes”.
While the flood of SPACs has now slowed to a trickle, most legal capital market experts say that SPACs are here to stay for the long term because the structures do have certain advantages.