Wall Street is taking "money for nothing" to absurd lengths.
To date, eight startups with no active operations to speak of have sold shares to the public this year, raising $410 million, according to investment banking research firm Dealogic. In all of last year, just six of these so-called "blank-check'' shells completed initial offerings, raising $275 million in the process.
The resurgence in blank-check IPOs, which have a history of being abused by unscrupulous stock promoters, is the latest sign that speculation is alive and well on Wall Street.
After all, what could be more speculative than shares in the IPO of a company whose sole
raison de etre
is to spend money on a business it hasn't even identified?
Talk about blind-faith investing.
"This is really a poke-and-hope situation,'' says David Menlow, president of IPO Financial Network, a stock-offering research firm. "It's something I would look at with a jaundiced eye.''
Menlow's skepticism isn't shared by the investing public. Besides the eight completed blank-check IPOs, there are another 17 deals still awaiting approval from the
Securities and Exchange Commission
The most notable of this year's crop of blank checks is
, a Bethesda, Md.-based company that's the handiwork of C. Thomas McMillen, a former Maryland congressman, NBA player and Rhodes Scholar. The six-month-old concern hopes to raise $42 million in an IPO to buy a company that "contracts directly with the government on homeland security projects."
In an attempt to ensure Fortress America's bona fides with investors and government officials, McMillen has attracted an all-star cast of characters from the defense and intelligence communities, including former Sen. Don Nickles (R-Okla.) and Asa Hutchinson, former undersecretary for the federal Department of Homeland Security.
Most blank-check companies are not targeted to a specific industry like Fortress America. In fact, most blank checks are vague in discussing their business strategies and leave a lot of discretion to the company's managers.
For example, the registration statement for
Aldabra Acquisition Corp.
, which raised $44 million from a February stock sale, said managers "may consummate a business combination with a company in any industry we choose and are not limited to any particular industry or type of business." So far, the New York City-based company has yet to find a business to back.
To protect investors, the SEC requires blank-check companies to deposit most of the proceeds from the IPO in an escrow account until a merger is completed.
Despite the flurry of blank-check filings, these companies in search of a business strategy often don't fare well in the real world of commercial finance. The prospectus for
Coconut Palm Acquisition Corp.
, which recently announced plans to raise $60 million, notes that 20 blank-check IPOs have been completed since August 2003, but "only one company has consummated a business combination."
Coconut Palm estimates that blank-check companies currently looking for a merger partner collectively have $650 million in the bank.
Trouble is, the type of businesses most likely to be interested in being acquired by a blank check are ones with shaky financial prospects. That's because the main attraction of blank checks is that they offer a route to public financing that avoids the expense and rigors of the IPO process.
Since blank-check companies begin their life on the OTC Bulletin Board rather than a major stock market, reputable companies tend to avoid them. It's difficult for a company going public in a so-called reverse merger to make the leap to a national market such as the
New York Stock Exchange
Nasdaq Stock Market
"For a financially distressed client, it may be an option,'' says Derek Meisner, an attorney with Kirkpatrick & Lockhart and a former SEC branch manager. "But it's a last recourse.''
Indeed, the SEC, on its Web site, specifically warns investors that blank-check companies "typically involve speculative investments" and should be treated with the same degree of risk as any other penny stock. The market for penny stocks notoriously has been one that's rife with fraud.
In 2002, for instance, the SEC charged four men with creating blank-check companies to acquire a series of small companies they secretly controlled. After the blank-check companies acquired the businesses, regulators charged the men then sold millions of shares without disclosing their interest.
Outright fraud isn't the only danger for investors in blank checks.
Given that it can be difficult for these shell companies to consummate a merger, an early investor in a blank check could be holding dead money for a long time. Moreover, since blank checks trade on the OTC Bulletin Board, where markets in stocks are illiquid, it can be difficult for an investor to unload shares. Some of the small investment banks that underwrite blank-check offerings don't even make a market in the stocks they bring public.
The recent trading in
Ardent Acquisition Corp.
, which raised $36 million in a March IPO, is typical of the uneven and sporadic trading in blank shells. In the first two weeks of trading, as many as 163,000 shares changed hands on a given day. But since then, there have been a number of days in which zero shares were traded in the stock.
On Tuesday, the stock opened at $4.95. In the IPO, the company sold a combination of 6 million shares and warrants to buy two additional shares for $6 apiece.
It's safe to say that the only investors likely to make out well in a blank-check offering are the insiders who put the deal together. Since the company has no operations, the founders don't have to invest a lot of their money as seed capital. And the sliver of money they do pony up often buys a bushel of stock at a deeply discounted price.
A few months before Fortress America filed its registration statement, the company sold 1.2 million shares to McMillen and other insiders at the bargain basement price of less then 2 cents a share. The company, meanwhile, hopes to price its stock at $6 a share.