Alternative Offerings: Going Public with Reverse Mergers & SPACs

In the recession a few years ago, initial public offerings nearly ground to a halt. Although IPO activity has since recovered, many private companies are considering alternative ways to go public. Reverse mergers, deals in which a private company becomes public by being acquired, are gaining in popularity.

In a reverse merger, the buying company pays for the acquisition target with stock. At the close of the transaction, the target company receives enough stock to have controlling ownership of the company that "acquired" it. Reverse mergers allow private companies to go public by taking over the identities of smaller publicly traded companies. The $9 billion merger of the NYSE Group Inc. into Archipelago Holdings was a reverse merger.

In the first quarter of 2006, there were 46 reverse mergers, up from 43 in the first quarter of 2005, according to data from The Reverse Merger Report, a publication of DealFlow Media Inc. Reverse mergers totaled $1.31 billion in market capitalization in the first quarter of 2006.

In addition to providing a vehicle for companies to go public, reverse mergers have also been used by foreign companies to enter the US market. Of the reverse mergers cited by The Reverse Merger Report, more than 20 percent involved foreign companies seeking US listings, with Chinese companies accounting for 60 percent of the foreign deals.

An SPAC is a publicly traded development stage company with no liabilities or assets whose only function is to make money for its investors by engaging in a merger or acquisition deal. The merger target is usually not known when the SPAC is formed. When the SPAC acquires another company, its shareholders get ownership of the target company and the SPAC's managers collect a percentage of any profit eventually generated. Investors unhappy with the acquired company can sell off their shares.

The use of SPACs declined in the 1990s, but they are once again on the rise. Since August 2003, 43 blank check companies have gone public. According to research from Dealogic, 69 companies filed plans to go public with the SEC in the first quarter of 2006, and six of those companies were SPACs. Of the 56 companies that actually went public during the quarter, 12 were SPACs. Not all SPAC companies succeed in making acquisition deals, however. Most SPAC ventures have provisions to return money to investors, less fees and expenses, if a deal is not completed within a specified time, usually 18 months.

A recent example of a successful SPAC is the merger of construction company Hill International Inc. with blank check company Arpeggio Acquisition Corporation. Under the terms of a deal announced in December 2005, Hill shareholders would receive 14.5 million Arpeggio shares, giving them nearly 64 percent of the combined company. Hill shareholders stand to receive further shares if certain key earning goals are achieved through 2007. The deal gives Hill International publicly traded stock and makes Arpeggio's investors into shareholders who stand to benefit if Hill increases in value. Hill officials have stated that added capital from the deal will be used to fund new company acquisitions in the US and abroad.

Although the IPO market is currently active, reverse mergers provide an attractive alternative for companies seeking to go public. Blank check companies make good targets for reverse mergers, since they are designed as shell companies specifically to enter merger deals. As more companies seek to become publicly traded, it is likely that reverse mergers and SPACs will remain popular means to that end.

Sources: Deal.com, ENR, M&A Insight, Mergers and Acquisitions