Unlocking Value in SPAC Distress: The Role of Private Credit
Unlocking Value in SPAC Distress: The Role of Private Credit
Many Special Purpose Acquisition Companies, or “SPACs,” that have merged with privately held companies are now trading at penny-stock levels, struggling to meet the lofty profitability forecasts made during their initial reverse mergers. While some may fail, there are others with valuable assets, unique intellectual property, or significant potential that have gone unappreciated in market headwinds. In previous posts, we wrote about SPACs, lender-on-lender violence, and private credit. Today, we delve into how these themes converge, particularly as private credit opportunity funds face a growing number of De-SPAC companies with attractive assets but shrinking liquidity.
As a simple introduction, a SPAC is a shell company whose primary asset is balance sheet cash funded with proceeds from an initial public offering. The SPAC’s objective is to identify an attractive acquisition target, communicate an investment thesis to SPAC shareholders, and then consummate a “De-SPAC” transaction in which the SPAC acquires the target’s operating business and assets. In the De-SPAC process, the acquiring entity usually needs incremental cash to pay the shareholders of the target. A frequent source of that incremental consideration can be preferred equity or convertible notes. Both investment structures are unsecured claims on the De-SPAC’d company.
Many De-SPAC companies have struggled to achieve profitability on the timeline originally forecasted when SPACs solicited their shareholders’ vote to consummate an M&A transaction with an operating company. As a result, there is a long list of De-SPAC companies trading at penny stock levels. While some may ultimately fail to prove they have the proverbial “reason to exist,” there are undoubtedly some that have fallen victim to baby/bathwater dynamics. For those companies with a compelling value proposition, unique IP, significant backlog waiting to be filled, etc., there may be a point-in-time chance for private credit opportunity funds to create convincing risk/reward scenarios for their investors while providing value to a De-SPAC company.
Extrapolating from an actual scenario, imagine that a private equity fund sought a partial monetization of a portfolio company via merging with a SPAC. The transaction was attractive to the sponsor because it provided a return of capital while putting new cash onto the company’s balance sheet to fund organic growth and opportunistic tuck-in M&A. Perhaps even better, the sponsor was able to achieve all of the above while maintaining effective control and possession of future growth in value through its remaining shareholding and board seats. All these benefits came to the sponsor using the proceeds of an IPO and a sizeable tranche of convertible preferred notes sold to help fund the acquisition of the SPAC’s target.
Since the De-SPAC transaction, the company’s performance has not matched projections, and the company now finds itself struggling to generate positive cash flow. While the company did identify an interesting tuck-in acquisition target that bolstered the De-SPAC company’s big data and AI capabilities, that target is not yet cash flow positive, further exacerbating cash burn.
Enter private credit opportunity funds. We previously noted the announcement of various private credit firms raising new investment vehicles to provide transitional capital that catalyzes a borrower’s ability to grow, bridge to a corporate event, achieve an operational turnaround, or even fund the partial or whole refinancing of fatigued existing lenders. In the hypothetical situation above, the convertible preferred notes happen to be trading at a large discount to par. The enterprising private credit firm with “opportunistic” dollars to deploy might suggest the following transaction to the company:
- Private credit fund begins buying some of the convertible preferreds in the open market at a discount.
- A private credit fund and a select group of other preferred holders then “roll up” their unsecured convertible preferred notes into a new first-lien loan.
- The rolled-up notes receive a premium to current trading value but less than par, thereby providing an immediate gain to the investors while the company benefits from realizing a discount on some debt.
- For every dollar of new first-lien loans provided in the exchange, the participating noteholders must provide $[0.50] of new cash.
The net result of the exchange is that:
- The company achieves a double benefit of enhancing liquidity while potentially even deleveraging the balance sheet depending on the trading level of notes and exchange ratio.
- The private credit fund and participating convertible preferred noteholders leapfrog over any unsecured claims to take the first position of all assets, including the enterprise value of the company.
- Non-participating noteholders who previously had no senior debt ahead of them are deeply subordinated and may even have any remedies available under their indenture stripped as part of the exchange transaction.
Although the scenario described above is fictitious, the fact pattern is grounded in observations of real De-SPAC companies and Configure’s ideas on creative solutions to tricky capital structure issues. Configure’s position as a leading debt placement advisor serving middle-market private equity funds provides us with a unique view into the needs of middle-market borrowers, their sponsors, and their lenders. We welcome conversations with sponsors, borrowers, and lenders alike to help craft bespoke solutions for middle-market credit.
About Matthew Guill
Matt joins Configure Partners from Greenhill & Co.’s Financing Advisory and Restructuring practice, where he most recently was a Principal. Prior to joining Greenhill, Matt worked on the restructuring teams at Rothschild & Co and Millstein & Co.
Matt has advised companies, lenders, sponsors, and governments on an array of complex financing and restructuring issues, M&A activity, and general strategic advisory assignments. He started his investment banking career at Cary Street Partners.
Matt graduated Phi Beta Kappa from Hampden-Sydney College where he was the captain of the basketball team. He also holds an MBA from Columbia Business School. Matt is a FINRA General Securities Representative (Series 63 & 79).