Hal S. Scott is the Emeritus Nomura Professor of International Financial Systems at Harvard Law School, and John Gulliver is the Kenneth C. Griffin Executive Director of the Program on International Financial Systems. This post is based on their recent paper, and is part of the Delaware law series; links to other posts in the series are available here.
Earlier this year, Michael Klausner and Michale Ohlrogge (K-O) posted a refutation of our paper, “No, SPACs Do Not Dilute Investors.” Their response provides no original analysis to refute our findings, merely reiterating the arguments they make in their earlier published papers. In this post, we establish why their response is hollow.
The heart of K-O’s mistake is their misallocation of all the costs of the merger of a public SPAC with a private target, referred to as a de-SPAC transaction, to the non-redeeming SPAC investors. The fact of the matter is that our paper and public proxy filings demonstrate that in reality costs are shared ratably between the SPAC and the target.
Their story goes like this: In a de-SPAC merger, all shares are valued at $10/share. This is true. But K-O then claim that the SPAC’s net cash per share (“NCPS”) – which applies all of the costs of the SPAC/de-SPAC process to the SPAC alone – reduces the cash per share from $10 to $5.70 for the median SPAC, and that is the value per share a non-redeeming shareholder can expect to receive in the de-SPAC merger. The mechanism to accomplish this, their story goes, is to inflate the value of the target above its actual value so that target shareholders get more shares in the merged company than they would otherwise. K-O contend that inflating the value of the target can shift costs.
We start with the base example, which prevails in reality, of how pro rata sharing of costs works. SPAC shareholders contribute their 10 shares each valued at $10/share, a total contribution of $100. The target company is worth $1,000. Target shares are also valued at $10 per share, so the target shareholders get 100 shares. Thus, before allocating costs, the combined entity is worth $1,100 with SPAC shareholders owning 10 shares (9%) and target shareholders owning 100 shares (91%). However, suppose the various costs of the merger, e.g. deferred underwriting fees and financial advisory fees, add up to $20 total, which reduces the value of the combined entity to $1,080. Each share of the combined entity is now worth $9.818 per share (not $10 anymore due to costs). The SPAC shareholder’s ownership is worth $98.18 (10 shares at $9.818 per share), and the target ownership is worth $981.82 (100 shares at $9.818 per share). The $20 of costs has been split pro rata between the SPAC shareholders, who pay $1.82 of the costs, and the target shareholders, who pay $18.18 of the costs.
K-O argue that the SPAC promoters and the target want to impose all the costs on the naïve SPAC shareholders. To accomplish this, the value of the target is inflated to $1,250 (over the real value of $1,000), so the target shareholders will receive 125 shares instead of the 100 shares previously. With the inflated value, the combined entity is worth $1,350 before costs. The SPAC shareholders still own 10 shares, but those now only represent 7.4% of the combined entity, down from 9% in the pro-rata example. The target shareholders receive 125 shares representing 92.6% of the company. Now when the $20 of costs are subtracted, the combined entity is allegedly worth $1,330 ($1,350 – $20). Since there are 135 total shares (10 for SPAC and 125 for target), the per share value of the entity is $9.852 ($1,330 / 135). READ MORE »
