China SPACs in US are Up, & Due Diligence is Key to Next Leg of Growth
Special Purpose Acquisition Companies, or SPACs, are increasingly popular alternative to a traditional IPO. With US SPAC transactions up for China companies, and dollar values up too, the stakes are rising to ensure US investors TRUST China SPACs. In this interview, I-OnAsia Director Ms. Lingbo Jiang takes stock of events and offers thoughts on the best approach to build trust by taking action: using I-OnAsia in the due diligence process.
What do we need to know about US SPACs and Chinese companies?
A SPAC is known on Wall Street as a “blank check company”. SPACs are popular alternatives to traditional IPOs, but we all know there are dangers with blank checks!
Indeed, a SPAC listing is actually pursued by high growth, particularly literal or figurative “moon shot” type businesses (autonomous cars, robotics, space exploration etc.) A SPAC is a way for a loss-making company to IPO quickly, while giving forward looking guidance and raising capital simultaneously. This is a high risk situation for investors in existing SPACs, but also for the advisors active in today's marketplace and tomorrow's SPAC candidates.
Although US companies account for the majority of SPAC activity, select Chinese companies have been using SPACs as a financing tool and gateway to US capital markets for more than a decade. Auto China International, A-Power Energy Generation System and Origin Agritech all went public via SPACs. This year, Chinese SPAC frequency has grown proportionally with the overall SPAC market. In February 2020, China-based CITIC raised $276 million with its SPAC-IPO of CITIC Capital Acquisition Corp. on the New York Stock Exchange. This summer, two new Chinese funded SPAC shells went IPO in anticipation of future mergers (Brilliant Acquisition Corporation and Greencity Acquisition each raised $40 million and are listed on the NASDAQ. In October, Bridgetown Holdings, a SPAC shell formed by Pacific Century and Thiel Capital, was listed on the NASDAQ, raising $550 million.”
What are the risks?
The resurgence of SPAC popularity is still early. There have been a lot of SPAC-IPOs this year, but there are also a lot of SPAC shells listed, including more and more that are “less traditional” (smaller, non-US funded etc). There is nothing "normal" about the current environment.
Indeed, I find it interesting that positives views outweigh the negative voices on SPAC-IPOs, despite the fact that there have been several failed SPACs already. In some cases this has been due to the target companies’ financial condition. For example, after being affected by COVID-19 impact, TGI Fridays terminated their SPAC merger with Allegro Merger this April due to TGI’s inability to meet necessary closing conditions. Other failures of SPACs are due to mis-representation or even fraud committed by the target company. For example, Akazoo, an AI music streaming company, failed to merge with Modern Media Acquisition Corp in 2019 because Akazoo made false and/or misleading statements and failed to disclose their financials, business operations, and details around music distribution rights and users, etc.
What is the SEC saying?
Although he did not issue this as a specific warning, the SEC chair Jay Clayton has advised investors to understand clearly the motivations of the SPAC sponsors, the companies they are purchasing and how the de-SPACing transaction is very different from that of a traditional IPO. The advisors who are involved in the SPAC process are going to be expected to help investors understand the differences too.
The SEC strictly scrutinizes the compensation and incentives that go to the SPAC sponsors in order to make sure the investors fully understand the incentives involved. When it is the time for investors to vote on the acquisition, disclosure to investors should be full and transparent, and to be fully trusted would need to meet the same level of rigor as in a traditional IPO.
What does this all mean for the advisors to SPACs involving China?
Advisors should be working with Chinese companies to ensure their deals avoid scandal. Long term investor reception depends on three core factors: the sector the companies is in, how much liquidity exists, and how trustworthy the company is seen as.
When it comes to SPACs from China, the risks are compounded by the current America's increased anti-China sentiment. Trust in SPAC quality is key. Failures and loss of trust could have broad negative consequences.
Enhanced due diligence into the backgrounds and activities of key principals and corporate affiliates is therefore about building value by anticipating the types of questions investors will ask to determine trustworthiness.
The recent batch of Chinese IPOs on the US exchanges have been small or mid-cap market businesses. Smaller SPAC IPOs can be challenging, as they often won’t attract the diligence or scrutiny associated with a big bank, or a traditional process. Plus, at the moment, the whole SPAC market is obviously frothy, so it’s only a matter of time before at least one scandal occurs.
Even without a full blown scandal, the compliance requirements of being a public company can be jarring to management not yet used to operating under the public scrutiny of quarterly results, and when you combine the accelerated process with the type of companies likely to look at a SPAC, the first few quarters of public life may be challenging. For the main firms are advising on SPACs, they already understand these issues and can help Chinese companies do this right.
What are lessons for China SPACs you can draw from your experience working on the trading floor of the New York Stock Exchange?
Large institutions want to trade in big blocks, with high liquidity, and in large market-cap companies. $1bn market cap is seen as a cut off point for many institutions. Given that most Chinese ADRs are traded in low liquidity and volumes, they draw less attention from investors on a daily basis.
For sure, Chinese investors have started to pay attention to SPACs, particularly after Antony Leung’s $1.5bn NYSE listed SPAC, New Frontier, helped the leading Chinese private healthcare provider United Family Healthcare go public last year.
But the biggest barrier to US investors paying attention is that they are usually not familiar with Chinese listings and the business practices they engage in. Most of the current focus of discussion today is about winning the trust of US based institutional investors by presenting GAAP based audited financials. For sure, proper independent accounting will help the listing process, and will speed up acceptance from US investors overall.
Due diligence by I-OnAsia is focused on other areas in backgrounds and reputation that market participants also want assurance on. There are some technical and geo-political nuances that I-OnAsia is uniquely qualified to address. For example, in the overlaps of technology and security. This is important because the tech and fintech sectors are more appealing to US investors than traditional sectors. Most IPOs today are for 'tech-enabled' companies.
Thank you, Lingbo, for these insights.
I welcome questions about how I-OnAsia’s cross-border expertise, and its strong footprint across multiple continents, can help with due diligence for a future SPAC transaction.
I have worked in cross-border banking my entire career, and most recently in the equity markets I have spent my entire career in cross-border business development for the financial sector. Prior to I-OnAsia, I worked at Citadel Securities, where I was the only Chinese native Designated Market Maker on the entire New York Stock Exchange trading floor. There I focused on both the pre-IPO market, pitching Chinese companies that wanted to list on the NYSE, as well as handling listed Chinese clients on a daily basis. Before that, I worked at Bank of China in their New York office. I also worked in the cross-border national security practice at a law firm. These roles have helped me build a deep network and given me the insights and knowledge about the opportunities and challenges facing cross border, particularly China/US, investment.