The twisted logic of reverse listings

The postmortem is still ongoing. But when the forensic analysis of Wirecard’s demise is finally complete, longtime duped investors will be particularly focused on one question: quite when did the cancer that killed the German tech star really take root?

Last month, former chief executive Markus Braun was arrested for a second time. Prosecutors suspect that he and other senior executives had been artificially inflating Wirecard’s revenue since 2015.

But might the rot have started much earlier? One theory has it that the company, which for years convinced investors that it was a soaraway success, despite a massive fraud at its heart, had never been properly scrutinised by its shareholders. New investors piled in largely because others had. And the baseline level of scrutiny that would normally take place when a private company first joins the public markets had not happened in Wirecard’s case: it never launched an initial public offering with a comprehensive prospectus. Instead, in 2005, it reversed into a defunct shell company called InfoGenie.

The tale is a cautionary one, given the high fashion for reverse listings these days. In the US, special purpose acquisition companies, or Spacs, last year accounted for a quarter of all IPOs.

Perhaps the most stellar Spac news of last year, literally, was the folding of Richard Branson’s Virgin Galactic space tourism business into Chamath Palihapitiya’s Social Capital Hedosophia Spac. Its share price has doubled this year.

The concept has gone from strength to strength in 2020, attracting ever bigger names. Last month one of four Spacs sponsored by former Citigroup banker Michael Klein struck a record $11bn deal for US healthcare company MultiPlan.

Then Bill Ackman’s Pershing Square hedge fund group listed the biggest Spac in history, raising $4bn. The shell company will spend the coming months scouring the world for acquisition opportunities — private companies that want an easier route to market than a full-blown IPO. 

Even before Mr Ackman’s deal, new Spacs had raised $13.5bn in 2020, according to Refinitiv, making this year a record.

Spac fans said it is a natural time for the sector to boom: many private companies are struggling following the coronavirus pandemic, and the lockdowns that accompanied it, and are seeking easy access to finance.

Stock markets are booming, giving Spacs a straightforward route to market. But there is nervousness among investors towards more complicated corporate IPOs. Spacs, backed by big-name sponsors, provide investors with the comfort of a trusted intermediary.

There are structural advantages too. In volatile times like these, it is attractive if a company can fix a price and execute a deal quickly, and avoid the delays and hassle inherent in filing an IPO prospectus and being scrutinised by regulators, before being able to list. Investment banks’ IPO fees, particularly hefty in the US, can also be mitigated.

The downsides are obvious. In some jurisdictions at least, the level of information that investors get of a company that reverse-lists is scant, though US Spacs stress that the disclosures in their merger prospectuses are just as fulsome as a mainstream IPO would demand. Another negative is the dilution effect for company owners and investors, effected via complex warrant structures attached to the vehicles’ listed equity. And there is an inherent conflict of interest in the value of payback for sponsors being tied to the price paid for a merger. Deals also tend to be magnets for a “Spac mafia” of arbitrage hedge funds which buy up the warrants to exploit short-term pricing anomalies.

Mr Ackman’s venture seeks to alleviate such concerns. Upfront fees are done away with, payback is via time-restricted warrants and Pershing has skin in the game, with $1bn of its own money in the fund. Short-termism is also discouraged by tweaking the traditional warrant structure to include a so-called tontine arrangement. This incentivises shareholders to remain invested for the long term because early sell-outs must hand their warrants to those who remain.

These new elements of financial engineering are smart and may do a lot to clean up the still tarnished image of greedy Spacs. Certainly Pershing Square Tontine appears to have attracted some of the biggest investors in the world, from Asian sovereign wealth funds to Canadian pension funds.

But at a time when stock markets are booming and companies, rattled by the pandemic, should be turning to equity markets for capital, it is hardly a ringing endorsement of efficient markets that such a cumbersome invention as the Spac is the thing that is thriving in lieu of IPOs.