Is the Spac investment model right?

By Stephanie Jacob

With two Spacs yet to secure a qualifying asset in the final year of their three-year deadline, and in view of the SC’s increasingly stringent rules, are Spacs as attractive to the market as they were originally when they were first introduced. And have they become any safer for investors?

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It has been slightly more than half a decade since the Securities Commission of Malaysia (SC) decided to introduce the special-purpose acquisition company (Spac) investment model into the market.

Since then, four companies, all in the oil and gas sector (O&G), have listed on Bursa Malaysia. Out of which only Hibiscus Petroleum, the first, has succeeded in securing a qualifying acquisition (QA) and has graduated to become a regular O&G-listed company on the bourse.

On July 16, 2015, Red Sena Bhd became the first non-O&G Spac to gain approval from SC to list on Bursa Malaysia. It will become Malaysia’s first food and beverage (F&B) industry Spac when it lists on Bursa Malaysia.

Among Red Sena’s directors is Tan Ang Meng, who was a former chief executive officer with Fraser & Neave Holdings Bhd. The company plans to issue 800 million new shares for 50 sen each and an equal number of free warrants, according to its draft prospectus filed in January.

Of late, there has been a lot of focus on the viability of Spacs again, mainly because Cliq Energy Bhd and Sona Petroleum Bhd (which listed in April 2013 and July 2013 respectively) have yet to complete their QAs, which need to be secured in the first three years from the point of listing.

Malaysia’s fourth O&G Spac, Reach Energy Bhd, was listed in August 2014 and therefore still has a significant amount of time to secure its QA.

The lack of non O&G Spacs has also been an issue of contention. Most recently, Eco World International, which is linked to Liew Kee Sin, abandoned its efforts to gain SC’s approval for a property-based Spac. In the past, mining Spacs and a plantation Spac had also failed to make the cut.

In all cases, SC refrained from commenting on its decisions, although it has maintained that there is no bias against non-O&G Spacs. What any prospective Spac management team must be able to provide is sufficient details of what it is promising investors and to show that its promises to investors in its initial public offering (IPO) prospectus are realistic.

Nonetheless, with SC approving Red Sena’s IPO, interest in the Spac investment model will likely be reignited. For one, it disproves a previously held belief that SC had a bias against non-O&G Spacs. This could result in promoters, who were previously sceptical of gaining approval, willing to give it a go.

The reaction from the market to an F&B Spac will also be interesting, O&G Spacs come with high risk but also with the promise of high returns, especially if a producing asset is secured. As for an F&B Spac, however, questions will be raised over how long investors will have to wait before they start to see a return on their investments.

What exactly is a Spac?

For the uninitiated, SC introduced the Spac model back in the latter half of 2009. Spacs are curious creatures because they list with no assets or financial track records, making them seem more or less like a shell company. Using the proceeds from its listing, a Spac’s management team has three years to find a suitable asset to be its QA.

While investing in a company with no track record may seem counterintuitive to most, under the Spac model, investors evaluate the company based on the strength of its management team instead.

The question an investor would ask is, do I believe the management team have the ability to take the funds raised at the point of listing and secure a suitable asset which will offer the returns they are promising?

SC said its decision to allow the Spac model into Malaysia was made to “promote private equity (PE) activities, spur corporate transformation, and encourage mergers and acquisitions to enhance the depth, breadth and competitiveness of the Malaysian capital market”.

In a sense, the concept is similar to that of a PE fund because, in both cases, money is raised from investors to acquire assets and then add value to them.

But there are several key differences, firstly unlike PE funds, in which money is raised from selected individuals and from institutional funds, Spacs raise money from the investing public, and therefore there is the need for greater and more comprehensive checks and balances.

The other difference is that unlike PE funds which are unlisted, Spacs are listed on Bursa Malaysia and can be actively traded.

Unsurprisingly, when the model was first introduced, it was met with much trepidation and even now, some investors and financial advisors tend to shy away from Spac companies. Recognising that the regular investors take on a lot of risks and that there is room for abuse, SC from the onset worked on a set of rules and regulations that had to be adhered to before and after listing.

Hibiscus Petroleum becomes Malaysia’s first Spac

Hibiscus managing director Ken Pereira said his company’s journey towards forming Malaysia’s first Spac began with the ambition to set up an independent exploration and production (E&P) company in Malaysia.

Speaking to KINIBIZ in 2013, Pereira said: “We were looking for a way to set up an E&P using the capital market… and at that time we had friends in Petronas who told us that Malaysian companies would soon be allowed into the (E&P) market.”

Eventually, he said that this access took the form of risk-sharing contracts, but it was still an indication that this market would be opened up to Malaysian companies, and this presented an opportunity for entry into the sector.

So he and his colleagues began looking at the Spac model. At that time aside from SC’s regulatory framework, there was little else in way of guidance for prospective Spac promoters. So Hibiscus had to largely create its own structure.

Pereira said that the concept was so foreign to Malaysia, that they wasted a few months working with a local investment bank, that simply could not come to terms with the Spac model. Therefore, he said Hibiscus had no choice but to develop much of it themselves, before finally taking it to Hong Leong Investment Bank who helped tidy it all up.

How have the Spacs performed?

Compared to Sona and Cliq, Hibiscus took less than a year to secure its QA. It bought a 35% equity stake in Lime Petroleum Plc, which was chosen for two key reasons, first it had four concessions in the Middle East; and secondly because it had a suite of proprietary technology called Rex Technology. This meant it graduated to a full-fledged O&G company on bourse.

In November 2013, Hibiscus, using its technology to choose specific locations, began drilling two wells, namely the Masirah North North and Masirah North East. Its management said the drills would prove the worth of the technology.

Despite their confidence, the wells were found to be not commercially viable. And from trading at RM2.04 on Nov 25, 2013 when drilling began, its share price fell to RM1.84 at the close on Dec 20, 2013.

Apart for a small recovery in share price at the start of 2014 when it rose to RM2.12, Hibiscus’ share price has been on a downward trend ever since. It is now trading at about 78 sen, which is about 4% higher than its IPO price of 75 sen.

For the other Spacs, share prices have moved mostly flattish since they have been listed, which is unsurprising given that they have no assets nor revenue which would increase the value of the shares. The most movements seen in Spacs share prices tend to coincide with talks about potential QAs.

But there may be investing opportunities in Spacs which offer high risk-free rates of return (see separate article). Some of them are trading below what an investor would receive if the Spac were liquidated and 90% of the trust funds returned.

Have tough SC rules dampened enthusiasm for Spacs?

Over the years, SC has been tightening the regulations even more. And the rules which Reach Energy had to adhere to are significantly more stringent than those Hibiscus Petroleum had to meet when it kicked off the Spac movement.

For instance, SC now only allows management to receive a maximum 90% discount and for initial investors to have a 40% discount on the IPO share price. This means that if the IPO price is 75 sen, then management and initial investors must pay 7.5 sen and 30 sen at least per share respectively. This is a significant change from when Hibiscus and Cliq paid only 1 sen for their shares.

Meanwhile, recent moratoriums on shares owned by management and initial investors have also been made much stricter than what was imposed on Hibiscus.

The moratorium on Hibiscus stated that its management team is not allowed to sell, transfer, or assign their entire interest from the time of listing on Bursa, until after they have acquired a qualifying acquisition. After securing a qualifying asset, the management team could then sell, transfer, or assign up to a maximum 50% of their securities per annum.

For Reach Energy, however, the moratorium stated that the management team are locked in up until their qualifying asset has commenced commercial production and has a full year of audited operating revenue.

Furthermore, 90% of proceeds from the listing must be put into a trust to be kept aside for the qualifying asset. And while under the initial rules, the remaining 10% could be used to pay salaries of the management team, SC has since changed that and now it can only be used for activities related to acquiring a QA.

What does this mean for Spacs?

It is arguable that the more stringent rules have made it less attractive to those looking to use the Spac model to access the market. The rules, three-year timeframe, in which to secure a QA and the moratorium which may extend substantially beyond that, may seem onerous to some prospective Spac promoters.

Nonetheless, given that the promoters still receive a hefty discount to the IPO price, once the moratorium ends, the burden shifts very much back to the retail investors. But Spac management teams argue that this is fair because, while the company is in its pre-QA phase, almost all the risks involved rest on their shoulders.

They say that if a QA is secured then it is a win-win for all, but if one is not then at least the retail investors get back almost all their initial investments, while the management team and initial investors lose their entire investments. Furthermore, the moratorium forces the management team to remain invested beyond merely securing a QA and this would help ensure they remain committed to the cause.

Supporters of the model also note that all trading on the market comes with some risks, and especially post-QA, Spacs in essence become like any other company on the bourse. Like in all the other companies, investors must be savvy enough to manage their investments.

To some extent, the SC rules do appear to be focused on protecting the retail investor. At least in that sense, the Spac model has improved as an investment option.

Nonetheless, given Hibiscus’ flattish performance so far, as well as Cliq’s and Sona’s slow progress in securing a QA, the question may now be if the Spac model is simply not worth the effort anymore.

In the next piece, KINIBIZ speaks to Hadian Hashim and Maznah Abdul Jalil who are the chief executive officer and chief financial officer respectively of Sona Petroleum Bhd to discuss the challenges of being a Spac, the concerns over investor protection, and if they believe the model is still worthwhile for prospective promoters of Spacs.

Below are the four Spacs that are listed on Bursa:

Hibiscus Petroleum Bhd

Hibiscus Petroleum Bhd took less than a year to secure its QA. It bought a 35% equity stake in Lime Petroleum Plc, which was chosen for two key reasons: first because it had four concessions in the Middle East, and secondly because it had a suite of proprietary technology called Rex Technology.

This technology was said to be able to better interpret data and determine if there is liquid hydrocarbon in the concession areas, which reduces the risk of unsuccessful drilling and increases efficiency. In a business where for every six or seven wells drilled only one is successful, the technology was touted as a game changer.

In late June 2013, an RHB Research analyst report said that Hibiscus, which was trading at about RM1.43 then, could possibly rise to as much as RM2.77 if it hit oil when it drilled in those concessions later in 2013.

In November 2013, Hibiscus, using its technology to choose specific locations, began drilling two wells, namely the Masirah North North and Masirah North East. Its management said the drills would prove the worth of the technology.

Despite their confidence, the wells were found to be not commercially viable. And from trading at RM2.04 on Nov 25, 2013 when drilling began, its share price fell to RM1.84 at the close on Dec 20, 2013.

Apart for a small recovery in share price at the start of 2014 when it rose to RM2.12, Hibiscus’ share price has been on a downward trend ever since. It is now trading at about 78 sen, which is about 4% higher than its IPO price of 75 sen.

Cliq Energy Bhd

On March 24, 2015, Cliq Energy Bhd announced that it has entered into a sale and purchase agreement (SPA) to acquire a 51% stake in two producing Kazakhstan oil blocks for US$117 million from a local Kazakh company, Phystech Firm LLP.

Managing director and chief executive officer Ahmad Ziyad Elias said Cliq will fund the purchase with a cash consideration of US$90 million following the completion of the SPA and a deferred cash payment of US$27 million at the end of the third year from the completion date of the SPA.

Currently, the oil blocks produce about 1,400 barrels of oil annually. Cliq hopes to ramp the production level up to 7,500 barrels over the next five years.

It is currently in the process of gaining regulatory approvals for the deal before presenting it to its shareholders. Cliq was listed on Bursa in April 2013 and therefore must complete the process before April 2016. Given the tight time frame, this QA attempt is likely to be Cliq’s last chance to graduate into a full-fledged O&G company.

In the latter half of 2014, Cliq’s share price trended downwards during the same period that oil prices were also sharply falling. At the start of 2015, it recovered slightly and has been trading mostly flattish since then. Its announcement that it had signed a deal resulted in a slight drop of 1.5 sen and since then there has been minimum movement in its share price.

Sona Petroleum Bhd

Sona Petroleum Bhd was listed in July 2013 and it has about one year left to complete its QA. Its management team has said it is confident it will be able to secure an asset before the deadline.

Sona had previously been in negotiations with Salamander Energy Ltd to acquire a 40% stake in two O&G blocks in the Gulf of Thailand for RM912 million. However, discussions fell through in January this year.

Instead, Salamander Energy entered into a share-swap deal with Ophir Energy Plc which valued the former at US$492 million. Ophir’s offer was conditional upon Salamander aborting its deal with Sona Petroleum.

Sona Petroleum and Ophir Energy then entered into discussions but that did not amount to a deal. Both parties mutually agreed to discontinue discussions in relation to Salamander’s assets earlier this month.

To date, since it first announced the Salamander deal, its share price has declined about 23% from 56.5 sen on June 5, 2014 to about 43.5 sen at end of July 2015. Since it officially announced it was ending discussions with Ophir in January, its share price has been flattish.

At Sona’s recent annual general meeting, its chief executive officer Hadian Hashim said: “We are still focused on looking at low-risk assets as part of our QA strategy in Asia Pacific. There are short-listed candidates with varying degree of maturity… Due diligence are being carried out, and we are confident that we will be able to complete the QA within the time frame specified.”

Reach Energy Bhd

Reach Energy Bhd was listed on Bursa Malaysia in August 2014 which makes it the market’s newest Spac, and gives it slightly over two years to find a QA.

Its management team has said it has shortlisted 10 potential assets. Reach’s chief executive officer and managing director Shahul Hamid Mohd Ismail has said: “Reach Energy is concentrating its QA search within the Asia-Pacific region. We are looking at mature oil fields in known regions or basins. Reach Energy is still open to other opportunities outside the region if the offer was attractive.”

Reach Energy’s IPO share price was 75 sen and it closed its first day on the market at 70.5 sen. Since then it has been trending downwards and it is trading at about 61.5 sen at the end of July 2015.

According to Hong Leong Investment Bank, that is 13% lower than its cash value of 71 sen. The research house opined that even in the worst-case scenario where Reach Energy does not secure a QA, investors would get back about 77.5 sen.

Spacs’ risk-free returns better than FD, says HLIB

According to Hong Leong Investment Bank (HLIB), special purpose acquisition companies (Spacs) can, in fact, offer risk-free returns that surpass what can be gained from fixed deposit investments.

The research house said that its investment thesis on Spacs is that its share base value should be determined by its gross trust value.

Under the Securities Commission’s regulations, Spacs have to put 90% of its initial public offering (IPO) proceeds into a trust account. Proceeds in the fund can only be used to purchase a qualifying acquisition or asset (QA). In the period before securing a QA, funds in the trust can be invested in approved investment opportunities, but all income made on these investments must be returned to the trust.

As mentioned, Spacs have three years to secure their QAs. If one is not obtained in time, then the funds in the trust are divided among the shareholders, allowing them to recoup most of their investments. Even in the event that a QA is secured, investors can choose to reject it, in which case the shareholders will be paid back from the fund.

HLIB said this guarantee is what makes investing in Spacs interesting.

In a report on the sector it said that “higher risk-free returns than a fixed deposit… (and) for investors with longer-term horizon, in the worst-case scenario, holding to maturity will translate to about 13% risk free per annum (for the three years time frame), which is significantly higher than the average fixed deposit rate of 3.2% per annum”.

Based on the gross trust value per share as at IPO, there is about 3% and 7% upside to Sona’s and Cliq’s share prices respectively. If interest earned on the invested proceeds is factored in, then there is an upside of 11% and 9% respectively, said HLIB.

Tomorrow: Interview: Sona sees opportunities from falling prices