We would be remiss (at the cost of sounding redundant) not to provide some basics on the what-and-how of SPACs. SPACs are utilized to fund a private entity in order to get that entity into the stock market. These private SPAC companies are able to sidestep some of the traditional underwriting processes and avoid weightier SEC rules. It’s a vehicle that avoids the conventional route of the initial public offering (IPO) and many of the complex issues associated therewith. The SPAC goes public, raises hundreds of millions of dollars from investors, then locates a target acquisition company and merges with that target. Sometimes a SPAC has a target already in mind upon its formation, but in many instances, it has a model and goes searching for targets. By rule, a SPAC has two years to locate and sign a deal, or it is required to return the investor monies (subject to extension by the stockholders). So, to get us started, there you have the nutshell definition of the special purpose acquisition company concept.
Why SPAC Versus Other Public Entry Avenues?
We have already mentioned the less onerous entry process of “going SPAC” versus the standard IPO approach. That is one very key reason. Next, SPACs are valued as being less expensive to achieve. Venture capital firms generally expect minimum returns in the 30% range. In contrast, capital-raising public equity SPAC events tend to target low teens to 20%, a big difference when talking millions. Still, such transactions must be considered with a guarded view from their dilutive effects. SPAC sponsors typically receive 20% of shares as a promote. Further, first-stage investors can characteristically redeem at merger, leaving the later investors (or non-redeeming investors) to bear the dilutive effect. I would caveat with the addition that the IPO process functions similarly.
SPACs in the Insurance Arena
Insurance is a unique industry, heavily laden with individual state compliance, financial regulations, and mandatory timelines. A SPAC focused on the insurance industry must clearly have a management team and board of directors highly knowledgeable in insurance specifics. SPACs have shown a history of starting out with one target model, and when targets are unavailable or cannot be completed, the SPAC model wanders into other industries completely out of the original objective. A group that is not highly insurance astute will likely not pass regulatory scrutiny in an insurance SPAC acquisition.
Timing will be a critical planning item involving an insurance acquisition. Acquisition of direct or indirect control of 10% or more of voting stock will entail advance change-of-control approval by one or more state regulators. The approval step could take three to twelve months based upon jurisdiction or multiple jurisdictions. State regulators will take careful time in assessing new control parameters involved with the acquired insurer (a heavily viewed item), review post-SPAC business plans, and resulting debt and equity structure. All this adds a layer of time, which must be contemplated in light of the two-year shelf-life afforded the SPAC structure.
SPACs historically tend to focus on EBITDA, in contrast to an insurance industry that tends to focus on the balance sheet. That has not deterred the chase of insurance industry targets. Further, “frothy valuations” (not my term, but one I like), and what GMO co-founder Jeremy Grantham calls “sidestepping the SEC prohibition on selling daydreams,” have reaped the hefty interest of SEC and state regulators in fears of investor or policyholder harm. Adequate due diligence by SPACs has been at the forefront of regulatory concerns.
So, what is the enticement of SPACs delving into the insurance realm? The hard market in commercial insurance line pricing has garnered high interest in the potential for extreme growth in this sector. Next, the insurance industry is fragmented in its many offerings and product lines. This affords the potential to streamline operations and add cost and pricing efficiency. The insurance industry holds long traditions in its method of delivery of products to consumers and its company-specific legacy administration systems. SPACs to the rescue? Maybe. The potential to reach the younger insurance buyer who favors speed and virtual interaction can lay aside the traditional insurance program through electronically-focused sales programs. The COVID pandemic has also augmented the role of technology in insurance, forcing companies to change stride in mid-stream to accommodate the isolation and remote sales needs, which again provides SPAC-focused opportunities for certain target markets. Finally, the SPAC market is nearing what we folks in the investment arena call frenzy…much government-induced, liquidity chasing, not-so-available, quality deals. FOMO is alive and well. With the short-tail timing of SPAC acquisitions and many competing players, the insurance business is a keen, old-line target to lay down that liquidity.
In our next SPAC series, we will visit what target insurance entity managements and boards of directors should be truly savvy about should a SPAC come-a-courtin’.