The use of special purpose acquisition companies (SPACs) as a tool to access public equity markets is expanding so rapidly that we expect a new annual record could be reached in the early months of 2021. Articles about SPACs are also booming in the financial press. Here we look at how these increasingly popular structures are considered from a credit perspective, as well as examples of how SPAC transactions have been favorable for existing, rated entities that reduced debt through a SPAC transaction. Successful transactions can be credit positives, but unintended consequences merit watching; for example, the possibility that SPAC-driven liquidity for acquisitions may lead to upward pressure on private-entity valuations.
Frequently Asked Questions
What is a special purpose acquisition company (SPAC)?
A simplified SPAC definition is a "blank check company" that raises funds and merges with an existing private company, resulting in the private company becoming a publicly traded company. Completing the initial business combination is the "de-SPAC" portion of the transaction.
SPAC sponsors can be either an individual or a company. Most SPAC funds raised through a public offering, typically at least 80%, are required to be held in an interest-bearing trust account and can only be distributed after a successful business combination or instead, returned to shareholders. Stock exchange rules typically require the SPAC to obtain shareholder approval through the filing of a proxy statement with the SEC.
How might public offerings affect credit quality?
Going public can be favorable for credit quality in several ways: if proceeds are used to reduce debt, then credit metrics are improved; if a financial sponsor is significantly reducing its stake, this may signal a more conservative finance policy under public ownership; and, the newly public company may choose to use shares, rather than debt, to pay for future acquisitions. S&P Global Ratings' focus is on how a SPAC offering affects the credit quality of an existing issuer that is acquired (and becomes public) via a SPAC acquisition. We are not addressing technical or market aspects: what enables a successful combination with a target (de-SPAC process); what additional capital could be available to a SPAC; why a SPAC could be attractive to a private company.
What market implications for credit quality are we watching?
One aspect to watch is how the recent (but potentially volatile) rally in SPAC transactions might result in additional competition for acquisition targets and inflate valuations into territory that raises potential for "overpaying" for assets supported by unrealistic synergy assumptions. The credit health of companies that pursued leveraging deals could quickly falter if growth slows for a prolonged period or access to capital markets becomes constrained.
What are the primary credit considerations when considering the impact of a SPAC transaction on a rated issuer?
SPAC funding nuances. Typically, the initial amount raised by a SPAC in an IPO is not enough to fund the entire acquisition. Total sources will typically include the SPAC net proceeds (after redemptions), rollover equity, PIPE (Private Investments in Public Equity), debt, and cash. Several of these funding sources have complexities which are not being addressed here. SPAC investors have an opportunity to exit the investment after a SPAC has identified a target. These exits are called redemptions and could lower net proceeds available, resulting in the need to fund the acquisition purchase price with more cash or debt. The post-transaction capital structure would be the starting point for our analysis.
Considerations of ownership structure, strategies, and financial policy (post-SPAC). In evaluating a SPAC, we analyze the post-merger ownership structure. Typically, SPAC owners consist of SPAC founders/investors, rollover shareholders (typically the prior financial sponsor), PIPE investors, and SPAC common shareholders. In the event the former owners (financial sponsors) roll over their equity, and retain at least 40% of the entity's common equity, or retain the majority of the voting rights and control, there are implications on our assessment of financial policy under our Corporate Rating Methodology.
The financial risk profile we assign to companies that are controlled by financial sponsors ordinarily reflect our presumption of some deterioration in credit quality or steadily high leverage in the medium term. We also consider the company's capital allocation priorities as a publicly traded company and how long-term leverage targets will look as private equity sponsor ownership declines. We find that most SPACs will not initiate dividends or share repurchases right away--this decision is often related to when financial sponsors or SPAC sponsors exit their shares, or when the company becomes less likely to make transformative, leveraging acquisitions. Public shareholders typically are less tolerant of very high leverage and/or companies that plan to execute a roll-up strategy and need room on the balance sheet for leveraged acquisitions.
How about governance (board, management)? Governance is a key credit factor in assessing the credit implications of SPAC mergers. Many SPAC founders have successful track records as investors or former executives in their targeted industries. For instance, Conyers Park and Collier Creek Holdings both backed SPACs that merged with The Simply Good Foods Co. and Utz Brands Inc., respectively. Both backers were founded by former packaged food executives who knew how to make changes to accelerate company growth strategies. As a SPAC, companies need to comply with publicly listed governance requirements, but may be deemed as controlled entities, if they have a large majority owner. As SPAC or existing private equity sponsors sell down their shares, we find that they also tend to vacate their board seats. Typically, most of the SPACs we rate, the existing management team continued.
Financial implications beyond debt reduction. While SPACs have generally meant deleveraging, there may be other liabilities, for example a tax-receivable agreement (TRA) put in place under the SPAC structure that could be treated as a debt-like-obligation; in some instances, the timing of payments under the TRAs may be accelerated or exceed the actual tax benefits. Companies may have to distribute dividends to cover their founders' tax liabilities as they sell down their shares. For instance, Hostess Brands Inc. maintains a sizable liability of about $157 million for the year ended Dec. 31, 2020, for tax payments to its legacy equity holders. While the company retains some tax benefits (15%) from this payment, it is a call on the company's cash, and we include that contingency in our debt ratios. Separately, under certain SPAC structures, warrants can be an additional source of liquidity for the company, albeit dilutive to shareholders. Most recently, Utz was able to redeem about $180 million of its warrants to fund an acquisition.
Is the potential impact on credit quality of rated issuers the same for SPACS and traditional IPOs?
Typically, the impact would be similar, if net proceeds reducing debt were the same in a SPAC or IPO transaction. While our view of credit quality is forward looking, we also incorporate the risk around a failed or delayed IPO, as well as how much company ownership remains with a financial sponsor(s) and may continue to influence financial policy.
What are some examples of rated issuers going public through a SPAC transaction?
A number of consumer products companies we rate have used SPACS. In all these examples, the positive rating actions reflected debt reduction with SPAC proceeds. On average, we've raised the ratings about one notch because of the improved leverage profile and our expectations for slightly more conservative financial policies.
Some companies remain majority owned by financial sponsors or we expect them to be highly acquisitive (the SPAC serves as a roll-up vehicle), leaving the risk of releveraging and limiting uplift to the ratings.
- Hillman Cos. Inc. (The) (B-/CreditWatch Positive from B-/Stable). The ratings are currently on CreditWatch with positive implications, and we indicated that we could raise the ratings to 'B' from 'B-' following the close of the transaction. The company's debt leverage will decline to roughly 4.5x from around 8x if the transaction closes as contemplated. The company will remain controlled by its financial sponsors at about 49% of the equity following the transaction.
- Whole Earth Brands Inc. (B/Positive from CCC/Negative--before sale). This was a new issuer (formerly Flavors Holdings). Under the new ownership and with less leverage, the company is executing on its portfolio diversification strategy by acquiring Wholesome Brands, which was in the 'CCC' category due to underperformance, high leverage, and near-term refinancing risk. We believe business prospects will improve with its new acquisition and lower debt leverage.
- Advantage Sales & Marketing Inc. (B/Stable from CCC+/CreditWatch Positive). The company was able to successfully refinance its upcoming maturities, and leverage dropped to 4.9x from 7.3x following the SPAC merger. We assume ASM will operate with more conservative financial policies as a public company, though its majority financial sponsor ownership constrains upside ratings potential. We expect the company to operate at lower leverage levels as a public company than it has in recent years (historically well above 6x). Nevertheless, financial sponsors still own over 60% of the company, and we believe they will continue to aggressively pursue mergers and acquisitions (M&A).
- Utz Brands Inc. (B/Stable from B-/Stable). Utz's leverage dropped to about 5x from 9x before the SPAC merger. The Rice/Lisette family retains ownership of about 50% of the company's shares, public shareholders about 41%, and its sponsors and independent directors hold about 9%. The company will likely remain acquisitive, though we expect its financial policies will enable it to maintain debt leverage of about 5x or below. Management's stated leverage target is between 3x-4x, with a willingness to go up to 4x for larger acquisitions. S&P Global Ratings-adjusted leverage is about 1x-2x higher because we do not add back various one-time items to EBITDA, and we include operating leases and bank guarantees as debt. We expect the company to remain acquisitive as it executes its salty-snack roll-up strategy.
- Post Holdings Inc. recently announced a corporate-sponsored SPAC that will fund a future acquisition. This appears to be one of the first corporate-sponsored SPACs and would provide Post with a source of equity funding for a future acquisition. The SPAC represents a minimal call on Post's capital and resources. The company is leveraging its financial and reporting infrastructure to maintain the SPAC and current management is listed as key officers. The company indicated it will seek targets in its core industry, packaged food.
What other sectors have seen SPAC activity?
SPAC transactions from the health care universe demonstrate that in most cases these deals, if completed, are credit-positive and lead to a noticeable leverage reduction. At the same time, a large portion of these entities remain majority sponsor-owned, which may limit the magnitude of post-IPO debt reduction or make it temporary. It also appears that a meaningful number of these transactions don't close for various reasons.
In the health care space, there are currently two in-flight SPAC IPO transactions that are expected to close in 2021--ATI Holdings Acquisition Inc. and Primary Care (ITC) Intermediate Holdings LLC. We placed the ratings on both companies on CreditWatch with positive implications, pending the close of their respective SPAC transactions and reflecting a potential for an upgrade, following the projected debt reduction upon going public. In the case of ATI Holdings, its existing financial sponsor Advent International is intending to remain the largest equity owner post-IPO and retain its control of the company, which will likely remain the defining factor in our financial policy analysis post-IPO, even with the projected leverage reduction.
On the other hand, not all transactions have closed. In 2018 health care issuer Agiliti Inc. (Universal Hospital Services Inc. at the time) pursued a SPAC IPO, after which its financial sponsor was intending to retain majority ownership and control. The company was planning to use the IPO proceeds for a material debt reduction, but the deal never closed. Similarly, in 2017 health care issuer Envigo Holdings Inc. announced a SPAC IPO transaction expected to result in a material reduction in leverage. However, that transaction was cancelled after a cybersecurity attack on Envigo.
Is there an example of a company executing a SPAC while becoming a rated issuer?
In October 2020, we assigned new ratings to supply chain software solution provider E2open LLC, which agreed to a $2.5 billion merger with a SPAC. As part of the transaction, the company proposed a new $525 million senior secured first-lien term loan B and a $75 million RCF. The merger agreement stipulated that these proceeds, along with up to $1.13 billion of equity (received in the merger), be used to refinance E2open's existing net debt, distribute cash to its existing shareholders, capitalize its balance sheet, and pay related fees expenses.
After combining with the SPAC existing owners, Insight Venture Partners was expected to have 38% of the public company and a minority board representation. E2open committed that it would maintain a leverage target of between 3x-4x as a public company in the proxy. We concluded that E2open would no longer be sponsor controlled. Our ratings highlighted our expectation for the contemplated transaction closing as presented with no significant changes and the merger closed in February 2021.
The technology team has also started to see transactions involving rated issuers and SPACs in recent months. There are currently two in-flight de-SPAC IPO transactions involving three of our rated issuers that should close later in 2021, with others anticipated.
- CCC Information Services Inc. (B-/Stable/--) announced an agreement to merge with SPAC Dragoneer Growth Opportunities Corp.
- SPAC Churchill Capital Corp. II announced an agreement to merge in a roll-up transaction with both Software Luxembourg Holding S.A. (Skillsoft [B-/Stable/--]) and Global Knowledge Training LLC (rated 'D').
While we believe these transactions may be credit positive, they require shareholder and regulatory approvals, and potential shareholder redemptions could create funding challenges. For now, given uncertainties, our issuer credit ratings on these existing issuers are unchanged, but there could be upward rating momentum for either the Dragoneer or Churchill transactions if debt reduction through the transaction causes leverage to decline below our upgrade triggers.
What about SPACs in the non-bank financial sector?
SPAC activity has thus far been confined to the asset manager and insurance services categories.
Some alternative asset managers we rate, including Apollo Global Management Inc., Ares Management Corp., and Oaktree Capital Management, are issuing SPACs to offer investments that may be far longer term than the typical finite life of private equity funds. As these managers source and close on targets, we'll focus on deployment and performance of the SPAC, governance of potential conflicts (such as regarding deal flow priority), and the ultimate revenues generated for the asset manager, among other factors.
Grosvenor Capital Management Holdings LLP (BB+/Stable) became a public company in November 2020, through a merger with a SPAC sponsored by Cantor Fitzgerald. Grosvenor management owns over 70% of the equity interest in the company--as was the case previously as a private company--which we believe allows for a strong alignment of interests.
MultiPlan Corp. (B+/Stable) provides cost-containment services for health care payors. The company went public via SPAC in October 2020 after being a long-time private equity owned company that changed owners four times during the 2006-2020 period (at rapidly escalating valuations). We continue to view MultiPlan as a financial-sponsor controlled company because it still owns a large stake and holds a sizable number of board seats. In terms of financial policy, MultiPlan indicated some intent during the SPAC process to reduce leverage more substantially over time. However, we expect MultiPlan's financial risk profile will remain highly leveraged for the time being as it ramps up internal investments and acquisitions as part of its new growth strategy.
This report does not constitute a rating action.
|Primary Credit Analysts:||Robert E Schulz, CFA, New York + 1 (212) 438 7808;|
|Bea Y Chiem, San Francisco + 1 (415) 371 5070;|
|Steven D Mcdonald, CFA, New York + 1 (212) 438 1536;|
|Joseph N Marinucci, New York + 1 (212) 438 2012;|
|Maryna Kandrukhin, New York + 1 (212) 438 2411;|
|Secondary Contacts:||Jeanne L Shoesmith, CFA, Chicago + 1 (312) 233 7026;|
|Gregg Lemos-Stein, CFA, New York + 212438 1809;|
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