How SPAC takeover financing has become Wall Street’s new favorite business

For most investors today, it is literally a “PIPE dream.”

PIPEs or private investment in public capital are mechanisms for companies to raise capital from a select group of non-market investors. But as PIPEs are increasingly deployed along with an increase in SPAC mergers, a larger group of fund managers are seeking access to this security, with limits on who and how much they can invest.

While SPACs, or special purpose procurement companies, will exploit public markets to raise capital to finance a future takeover, PIPEs are allocated to a small group of investors. Fund managers participating in PIPE will sign a non-disclosure agreement, with trading restrictions, and will be brought over a proverbial “wall” where they are provided with non-public material information from SPAC about which they are seeking to acquire a target. They are then allowed to choose whether or not to invest in SPAC’s IPO price – or sometimes at a discount – and pay what they hope will be a pop when the takeover is announced.

Bankers from several companies told CNBC that they recently received an increase in interest rates from investors looking for future PIPE opportunities.

“Many of these transactions are going very well and have been well received in the post-announcement period,” said Warren Fixmer, who leads SPAC Equity Capital Markets at Bank of America. “So the alpha generation it represents obviously attracts a wider group of investors.”

In 2020, PIPE generated $ 12.4 billion in additional capital to help fund 46 SPAC mergers, according to data extracted by Morgan Stanley. Their data analyzed SPAC transactions with valuations of more than half a billion dollars. On average, PIPE capital added almost three times its purchasing power to SPAC, Morgan Stanley said. For every $ 100 million raised through a SPAC, a corresponding PIPE added another $ 167 million, the data show.

Some of the largest PIPEs have exceeded $ 1 billion in size and have been engaged in recent months. The latest was announced Monday morning, with Foley Trasimene taking over Acquisition Corp. of Alight Solutions, which included a $ 1.55 billion private placement. Another Foley SPAC used a $ 2 billion private placement, announcing an agreement in December to acquire Paysafe. SPAC, the share capital of Chamath Palihapitiya’s Hedosophia V, launches a $ 1.2 billion PIPE to acquire SoFi. In addition, Altimar Acquisition Corporation has announced an agreement with both Owl Rock and Dyal to bring the combined asset manager with a $ 1.5 billion PIPE to the public.

More committed PIPE will remain with SPAC IPOs, which means that if 2020 was the year of SPAC growth, 2021 and 2022 will be the time when these vehicles will merge.

Morgan Stanley data showed that there is still more than $ 90 billion worth of “dry powder” to be implemented for procurement in the next two or fewer years. This involves a total of $ 117 billion in PIPE capital to be raised in connection with SPAC mergers in the meantime, Morgan Stanley said.

In this context, potential PIPE investors are asking for mass investment agents and want to be included in the financing of these mergers, bankers from three separate companies told CNBC.

The increased prevalence of this product raises concerns about the potential lack of understanding on the part of the wider cohort of SPAC investors on how these investments work.

“There are two generic losers, or people at risk: the first is existing shareholders, but the second is the perception of the fairness of our capital markets,” said Harvey Pitt, former chairman of the Securities and Exchange Commission. “People who are unaware of the disclosures, people who are not able to benefit from these price reductions and people who see the power of equity holdings degraded by virtue of what we call dilution. ”

PIPE investors usually receive their securities at a discount at least at market price and sometimes even receive shares below the IPO price. About a third of SPACs in the 2019 to 2020 merger cohort that issued shares in PIPEs sold shares at a 10% or more discount to the IPO price, according to a recent SPAC study by Stanford Law School and New York. University School of Law. This can ultimately be diluting for investors who have purchased shares in the SPAC IPO.

A key question, Pitt said, is what types of disclosures PIPE investors receive compared to the wider market. Although he notes that it would be “fully appropriate” for SPAC to share potential merger plans or things like that, other details about the company’s future could be a grayer area.

But PIPE supporters say they serve as a signal to validate the market and can therefore improve performance. According to Morgan Stanley, those SPACs in 2020 that included PIPE had an average performance of 46%, one month after the closing of transactions. Those without PIPE recorded earnings of less than half (21%) in the same period of time.

But once PIPE investors are eligible to sell, this can put pressure on the global stock as the float widens. This usually happens in the weeks following a SPAC agreement – much shorter than a typical IPO block.

Because of these factors, PIPE could be an area that attracts more regulatory scrutiny this year as investors begin to better understand the rules and the potential financial impact around these securities relative to public shares in SPACs.

“It’s not illegal to engage in one of these offers, but there are, say, minefields throughout the process that could turn what might be legal into something illegal or cross that line,” Pitt said. who currently serves as CEO of Kalorama Partners, a consulting firm. “That’s why there has to be control and that’s why there is control of these transactions.”