Better Understanding of SPAC and Related Considerations
2010/04/20 1 Comment
Since the first SPAC had been listed on KOSPI early March, three SPACs, initiated by well-known big securities, successfully went public so far; Daewoo Securities Green Korea SPAC (Daewoo SPAC), Mirae Asset 1st SPAC (Mirae SPAC), Tongyang Value Ocean SPAC (TY SPAC). Surprisingly enough, the market reacted more than expected. For instance, the price of Daewoo SPAC has significantly gone up to more than 41% of its initial offering price. Also the price of Mirae SPAC has more than doubled itself since its initial offering.
Despite the fact that it is not unusual that any IPO stocks tend to be traded higher than its initial offering price during their honeymoon period because not only investors expect them to perform more than initial value, but also IPO advisors usually discount the initial offering value lower than their intrinsic value in order to attract more subscription, the recent price movement of SPACs can be considered as an unreasonably irrational speculation. Since SPACs shall have no operation or history whatsoever before their IPO in nature, which differentiate themselves with other IPO cases in general, basically it is impossible to estimate their intrinsic value, which can be estimated from the company’s historical operation and business plan. Also, regulation clearly stated that no SPACs are allowed to negotiate with the potential target company during or even before their IPO process. According to the unconfirmed information, there are rumors that some SPACs might have been negotiated with a target company even before they went public. If it turns out to be true, it is absolutely against the law and can be considered as a money game and unreasonable speculation. In a nutshell, there is no reason for each investor to respond with excitement now. In order to avoid not only any possible wrongdoing on SPACs, but also financial damage and cost to general investors from a possible fraud and money game, it is necessary for us to understand the characteristic of SPACs and the operation process.
Pursuant to commercial law and capital market and financial investment business act, typical M&A Process of SPACs is as follows;
Upon the mutual agreement with target company, SPACs shall implement the exchange ratio estimation process in order to estimate each value of companies and decide a portion of premium paid to target company’s shareholders. To maintain its fairness, professionals, such as accounting firms shall be selected as an independent evaluator. There are two cases of exchange ratio estimation based on the regulation. First, SPACs intend to merge with a listed target company. Since both are listed, the ratio should be estimated based on the closed price of the day before the earlier event of either M&A agreement or resolution of board of director (base day), adopt the minimum closed price between average of closed price for a month, for a week, of base day and the closed price of base day.
Min ( Average price [ 1 month, 1 week, base day ], Price of base day )
Second, SPACs intend to merge with unlisted target company. The value of target company should be estimated as follows;
Average (｛[ (NAV1 × 1) + (IV2 × 1.5) ] ÷ 2.5 ｝, MV3 )
1 Net Asset Value = Net Asset ÷ Total Number of Shares
2 Intrinsic Value = Forecasted Income per share ÷ Discount rate
3 Multiple Value : estimated value per share compared to other listed competitors. Can be disregarded in case that no listed similar companies available.
Based on the value estimated by independent evaluator, the exchange ratio shall be made upon mutually agreeable basis. Typically exchange ratio is skewed because the target firm’s shareholders are paid a premium for their shares.
During the process, it is also necessary to consider possible tax issues for both companies and shareholders. Possible taxes can be imposed on each interest parties are as follows;
As for an amalgamated company, SPACs itself can be exposed to pay taxes on merger margin during merger process; however, taxes can be deferred (not exempted) on the condition that SPACs proceed their deal at least 1 year after IPO, which means that it is unreasonable to expect any deal could occur within 1 year since their IPOs. For a merged company, the target company itself is subject to paying taxes on liquidation earning since officially it is sold to SPAC. However, since all assets and liabilities are supposed to be taken over by SPAC when merger occurred, no earning shall be drawn to pay taxes on. It is highly likely that shareholders of the target company are subject to paying taxes on their fictitious dividends during the process. Since shareholders of the target company is supposed to receiving new shares issued by SPAC during the merger process. By the tax law, it is considered as an economic earning and subject to levy taxes (15% of a standard of assessment).
[ ( Paid-in-Capital of SPAC × exchange ratio* ) – Paid-in-Capital of Target Company ] × 15%
* For example, suppose exchange ratio is 1 : 3 (SPAC : Target), choose 3
If either value of SPAC or target company is significantly greater than the other, the tax burden to shareholders of the target company can be increased proportionately. Due to the heavy burden of taxes, shareholders of the target company might reconsider the deal with SPAC and it might cause the cessation or cancellation of deal.
Even though both companies agree with terms and condition of the deal, the financial authorities also have to conduct the study of its merger until it’s officially approved in terms of legal and financial soundness.
Considering the process of SPACs, obviously investing on SPACs should not be considered as a short term deal, but mid-long term investment. The recent enthusiasm on SPAC need to cool down until actual deal occurs (at least not until 1 year from now). Better understanding of SPAC and its characteristic should be beneficial for investors to not only obtain a successful investment, but also contribute to maintaining the soundness of financial market.