Don’t fear the cash shell

While cash shells are similar in nature to private equity funds, fundamental differences between the two means the buyout industry has nothing to fear from them, says Alex White, Partner at BDO.

The re-emergence of cash shells and Single Purpose Acquisition Companies (SPACs) over recent months has prompted significant coverage in the press and heralds a growing appetite for risk in the capital markets. Whilst Private Equity weathered the storm as a financial vehicle during the recession, the renewed interest in cash shells raises the question of what roles the two should occupy in the new financial landscape.

It has been said by some that subscribing to the IPO of a SPAC is like investing in a private equity fund, but without the lock up of five to ten years. This notion has sparked the debate over the extent to which SPACs and PE houses complement or antagonise one another.

Alex White

Whilst at first glance these two investment mechanisms may appear broadly comparable there are a number of quite fundamental differences between the two. Firstly, there is the volume of deals undertaken by each: whilst cash shells, such as the recently launched Horizon 2, may end up containing more than one acquired company, they are unlikely to progress to more than two. An example of a cash shell with a sole company in its portfolio is the recent announcement by Vallares (backed by former BP leader Tony Hayward) of its intention to merge with Genel Energy, a Turkish oil exploration group. 

The merger will be achieved through an all-share reverse-takeover in which Vallares will issue new shares worth US$2.1 billion at a price of £10 a share to acquire 100 per cent of Genel, giving Vallares and Genel's current owners equal stakes in the combined business.Having already significant cash on IPO the new combined group is expected to have a market value of about $4 billion, putting it into contention for eventual inclusion in the FTSE 100 index. At this size, further purchases by Vallares are unlikely.  Whereas a PE fund diversifies its risk, building a broad portfolio of investments across sectors, with a SPAC there is a much higher risk concentration investing in fewer assets.  

Secondly, with regards to cash shells, once a target has been identified, shareholder approval may be required to make the acquisition. This can lead to differences of opinion on the investment strategy and little scope to placate investors through a diversification strategy. A private equity fund managed by a stable General Partner is generally allowed to pursue a single investment strategy with greater scope to manage risk in the portfolio.

There is, however, a major upside to investing in cash shells; they offer smaller shareholders a liquid market for their shares which investing in a PE fund does not.  However, the downside is that the timing of transactions is often out of shareholders’ control which will affect liquidity until a deal has been closed. Hugh Osmond, serial entrepreneur and founder of Horizon and Horizon 2, took over a year to find his first target, APR Energy, for his original Horizon cash shell.  Under the terms of the transaction the original shareholders of APR ended up owning 59 percent of Horizon in a paper deal which would have been a surprise for first investors Similarly Genel is owned by the Çukurova Group, one of Turkey’s largest conglomerates and soon to be a circa 50 percent shareholder in Vallares.

As with any significant change in a shareholder base, there will be uncertainty about shareholders long term intentions and the effect of any overhang potentially impacting on liquidity and value.  Instances like the Vallares and Horizon deals demonstrate that investors, who would like more comfort on who the major shareholders are  – a case of “better the devil you know” – are probably better off avoiding SPACs.

Typically a cash shells’ investment strategy is based on the sector expertise and specialism of their special advisers/ promoters. Depending on the sector a firm operates in, SPACs can be sources of competition. In the case of Vallares, Tony Hayward is likely to target specialist oil and gas production assets which, as a sector, are not expected to appeal to private equity. More competition on the other hand may present itself with Horizon 2, especially if it becomes a buyer of larger distressed PE investments.

“Net Net” and balancing the threat of new competition with the opportunity to dispose of unwanted assets, the PE industry has nothing to fear from these cash shells. Although the larger few may carry a high profile, they are actually relatively few in number. There will not be many of them because they are fundamentally risky wrappers for one or two as yet uncertain investments and because success at the fundraising stage is dependent on the celebrity ‘draw’ of the name behind them (i.e. Lord Browne, Hugh Osmond, Tony Hayward.) Investors need to feel comfortable with that risk or steer clear because in essence it is about backing the jockey not the horse.

Alex is a partner in the London corporate finance team, focusing on M&A and raising finance.  He has advised on a wide range of private and public company sales, acquisitions, re-financings and public to private transactions.  Alex has particular expertise in running cross border company sale processes and structuring leveraged private equity transactions for PE Providers, company owners and MBO teams. Alex is a qualified accountant and joined BDO Corporate Finance in 1995.