Writing a Blank Check

To casual observers, Services Acquisition Corp. International’s acquisition of the California-based restaurant chain Jamba Juice may not seem unusual. After all, mergers/acquisitions happen all the time for a variety of reasons (economies of scale, access to new markets, etc). So what business was SACI in that it wanted to acquire Jamba Juice? Why … no business at all.

Services Acquisition Corp. is part of a new wave of “blank check” IPOs, acquisition companies going public with no operations or clear plan, only a promise to acquire other companies within two years. In fact, its June 2005 prospectus only says the management team plans to look at companies in the service industry (no mention of restaurants or similar).

Securities and Exchange Commission (SEC) rules require “blank check” companies to identify a takeover target within 18 months of going public, and deals must be closed within 24 months. If no deal is made, the company must return the investors’ money (held aside in an interest-bearing account) minus some fees and expenses. This can be tricky because, as University of Florida researcher Jay Ritter notes, blank-check executives have “every incentive to do a deal, whether it makes sense or not, because if they don't do one, they give the money back.”

Nevertheless, more than $3 billion has been raised by blank-check IPOs over the past two years and there are no signs of a slow down. Industry opinion about the ventures are split.

1. A moral hazard exists when, after an agreement has been made, one party has an incentive to take an action that it benefits from at the expense of the other party. Identify where a moral hazard may lie for “blank check” companies. Does the magnitude of this moral hazard increase or decrease over time?

2. Some analysts claim the risks associated with “blank check” companies are overstated. After all, if a deal is not made, investors get most of their money back (limited downside risk). Describe a scenario where this might not be true.

Topics: Finance, Initial public offering (IPO), Moral hazard, Incentives, Merger