Finance & economics Company buyouts

Frenemies The uneasy partnership between private equity and SPACS

The spectacle of the SPAC, or "special-purpose acquisition company", has preoccupied bankers on Wall Street over the past year. This is in part because the vehicles, which list a shell company on stockmarkets and raise a pot of capital before hunting for a private company to merge with, are often touted by their backers as an alternative to an initial public offering (IPO).

Big banks make meaty fees from their IPO businesses. For some, the fact that SPACS have muscled in is an unwelcome development. As voracious buyers of private firms, though, SPACS are attracting as much attention among the private-equity (PE) barons on New York's Park Avenue as on Wall Street.

Since the start of 2020 SPACS have gobbled up almost $200bn in capital. The way they are constructed makes them prone to overpaying for firms. Creators see no compensation unless they strike a deal with a mergertarget, which must often be done within two years.

The founders' payoff is usually 20% of the shares the SPAC helps issue in the newly public firm, which are given to them for a nominal fee. This means that even if the shares plunge afterthe shell company merges with its target, the founders are still well compensated.

Their incentive is thus to do any deal they can, at lofty prices if necessary. This tendency to overpay is both a blessing and a curse for PE.

If a PE firm is looking to offload one of its portfolio companies, then finding a SPAC to buy it is an attractive prospect. In March Blackstone and CVC Capital Partners, two PE shops, tripled their money when they sold Paysafe, a payments platform, through a SPAC mergerled by Bill Foley, an insurance executive.

After Blackstone achieved record first-quarter earnings of $1.75bn Jon Gray, its president, noted on an earnings call that SPACS had emerged as a new exit option. But PE firms also need to purchase private companies fortheir new funds, ideally at low valuations if they are to make the juicy returns theirinvestors have come to expect.

Little is known publicly about the deals that PE firms miss out on, but reports abound of SPACS bidding 20-50% more for companies than the most optimistic valuations by analysts in PE shops. A further complication in the relationship between blank-cheque vehicles and PE is that some PE giants are setting up SPACS themselves.

Apollo, for instance, has launched five in recent years. That could pose a dilemma: should a target firm be bought through the private arm, to the benefit of the investors in the PE fund, or by the public arm, to the benefit of the investors in the SPAC?

The SPAC frenzy might yield juicy returns for PE investors who bought into a fund a decade ago. But tricky choices loom.