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Acquisition companies trade on trust to attract shareholders' checks

By David Milstead, Rocky Mountain News (Contact)

Saturday, March 15, 2008

Investing in a company always involves a certain amount of trust in management. Investing in a "blank check" company, though, is like . . . well, writing them a blank check.

The newest versions of these firms are called "special-purpose acquisition companies."

An experienced set of managers sells stock in a new company that has no operating business. They collect money from public investors and promise to find a company to buy. And hopefully they make money, raising the stock's price.

Some familiar names in Colorado business - and politics - are in on the trend.

Two years ago, Stephen Hughes, a former executive at White Wave Foods and Celestial Seasonings, raised $102.1 million at Boulder Specialty Brands.

Energy industry legend Cortland Dietler has teamed up with Patrick McDonald, the former CEO of Denver-based Carbon Energy, for a $115 million acquisition company. Mark Wattles, the owner of Ultimate Electronics, plans to raise $230 million through his vehicle.

And former Gov. Bill Owens serves on the boards of two East Coast blank check companies. One raised $123.25 million in October, while the other hopes to raise $400 million.

More than two decades ago, the name "blank check company" was nearly synonymous with fraud. Penny stock scam artists created empty shell companies, whisper about coming deals and dump shares for big profits, said Phil Feigin, the former Colorado securities commissioner who now practices at Denver's Rothgerber Johnson & Lyons.

These days, however, the special-purpose acquisition companies have been one of the hottest financing vehicles on Wall Street. In 2003, only one went public, raising $24 million, according to research firm Renaissance Capital. In 2007, 65 of them raised $11.7 billion.

Wattles said the blank check companies of the past "were such small deals and didn't have such a good reputation. Now you're seeing credible entities."

Wattles already has a private-equity vehicle, Wattles Capital, funded with his own money. But he formed blank check Wattles Acquisition Co. because he believes that some companies ready to sell prefer a publicly traded buyer.

"It has advantages to the target company that a private-equity fund doesn't have: ongoing liquidity, easier access to the capital markets, the ability for founders to maintain significant influence, if not control," Wattles said. "The companies I would be interested in would be attracted to private-equity funds, so I've got to have a vehicle more attractive than a private-equity fund."

Another thing that makes the vehicle attractive to a selling company, said IPO analyst Francis Gaskins, is going public without filing the lengthy registration statement required by the Securities and Exchange Commission.

"The companies they acquire don't have to do the full-disclosure requirements you have to do with an IPO," said Gaskins, who maintains the Web site IPO Desktop. "They avoid the glare of the SEC."

That might be a red flag for the investors, although there are protections in place now that didn't exist in the bad old days. The proceeds from the IPO are held in escrow. The blank check companies have a certain amount of time, typically 18 to 24 months, to make a deal. Then, shareholders get a vote on the transaction.

If the company can't meet these terms, nearly all the money is returned to investors.

These are rules the SEC has placed on blank check companies. Since most of the new special-purpose acquisition companies are raising large amounts of money and plan to trade around $10 a share, they aren't technically "blank checks" in the SEC's eyes. But they've adopted the blank-check restrictions to appeal to investors.

"Shareholders are not giving their dollars blindly," Wattles said.

Still, the deals can be immensely lucrative for the founders, who put in a small amount of money upfront and receive significant ownership in exchange.

In June 2005, during the formation of the company, Hughes bought 1,225,519 shares in Boulder Specialty Brands for eight-tenths of 1 cent per share. The company, now based in New Jersey and known as Smart Balance, trades around $6.50 a share today, making his stake worth nearly $8 million.

Owens was able to purchase 20,700 "units" in Highlands Acquisition Co. for 1 cent apiece when he joined the board last year. The units held one share of stock and one warrant to buy a share for $7.50.

Highlands Acquisition, which went public in October but has not made an acquisition, trades at about $9 a share, making his stock and warrants worth roughly $215,000.

Owens received a similar deal at Kanders Acquisition Co., which is run by the same management group as Highlands. He and other directors bought 28,750 units for $62.50, or about two-tenths of 1 cent apiece.

Dietler, McDonald and two other executives in National Energy Resources Acquisition bought 2,875,000 shares of common stock for $25,000, or nine-tenths of 1 cent per share.

McDonald, Hughes and Owens all declined to comment.

Wattles may have the best deal of all.

Wattles Capital paid $25,000 for 5.75 million shares of Wattles Acquisition Co., roughly four-tenths of a cent apiece. Wattles Acquisition plans to sell its units of one share and one warrant for $10 apiece, which would make Wattles' stake worth more than $50 million.

While the payoff may be large when compared with executive pay for a hired CEO, Wattles believes it's less than what a hedge fund manager or private-equity fund would take from a deal of this magnitude.And theThe blank check concept allows individual investors to buy into deals normally reserved for private equity. Whether that's a good thing for them is unclear. Bloomberg News, using data from research firm SPAC Analytics, reported in January that an investor would have been better off in an index fund, since the average annual return of blank check companies in the past five years has been 5.8 percent compared with 13 percent for the S&P 500.

"When you invest in a company that has no business and says, 'We're going to go find and buy something interesting,' you're clearly investing in the promoters. And there's a bit of suspicion you don't know what you're getting into," Feigin said.