Blank Check, Blind Faith

No assets, no staff. But shells created to buy companies are hot IPOs

It takes a lot of faith to buy stock in any initial public offering. But it may require the faith of a saint to invest in Fortress America Acquisition Corp. The five-month-old startup, which filed its prospectus on Mar. 23, has no revenues, operations, products, or employees. It lists $72,500 in assets, including $60,000 that was borrowed from its officers. Nonetheless, it hopes to raise $42 million by selling 7 million shares.

And what would it do with the money? The Bethesda (Md.) outfit would buy an as-yet-unknown company in the homeland security industry. It may succeed. Asa Hutchinson, who was undersecretary of the U.S. Homeland Security Dept. until Mar. 1, is a special adviser and one of the five original investors. Still, Chairman C. Thomas McMillen and Chief Executive Harvey L. Weiss acknowledge that they have no leads yet on what to buy.

Fortress America is a "blank check" company -- a shell created solely to acquire a single operating business. And while financial advisers warn that investors are buying blindly, these stock offerings are the hottest thing in IPOs today. There was only one in 2003, but 12 were launched last year, according to researcher IPO Vital Signs (WTKWY ). This year, six more have begun trading, more than in any other category of new listings, and 22 others have filed with the Securities & Exchange Commission to issue shares. Some specify which industry they're targeting; others are open-ended.

The size and stature of these IPOs are also growing. Last year they raised an average of $43.2 million each and all but one were oversubscribed, says Glenn A. Petersen, managing partner at Calyx Partners, a small-business consultancy in Chicago. Current registrants are seeking an average of $74.3 million, including two for $180 million each. Marquee name execs are signing on as principals. Steven R. Berrard, former CEO of Blockbuster Entertainment Group and co-founder of AutoNation Inc. (AN ), heads Services Acquisition Corp. International in Fort Lauderdale.

Financial advisers say investors have flocked to blank-check companies because of the attention that hedge funds and buyout firms have been getting. Like them, the new outfits aim to unearth diamonds in the rough that could become gems with enough capital or management skill. Unlike hedge funds, they are open to all, not just the wealthy, with shares typically priced at $5 or $6 apiece. Startup execs see them as a way to raise money without ceding a big stake to angel-fund investors or without going to banks, which would require a detailed business plan. New York investment bank and brokerage EarlyBirdCapital Inc., a leader in the business, has backed 18 of the deals.

But do investors come out ahead? It's too early to tell, because only one recent blank-check startup has done a deal. In August, Millstream Acquisition Corp. of Wayne, Pa., took over NationsHealth Inc., a money-losing medical-products supplier in Sunrise, Fla., for $20.9 million. Millstream's stock, issued at $5 a share, now trades as NationsHealth (NHRX ) on NASDAQ at around $6.25. Three other blank-check companies have announced deals expected to close in the next few months, while Millstream launched a second IPO in December. Irwin Greenstein, editor of Penny Sleuth, an online newsletter, warns people to stay away from the sector. "If you want to gamble, go to Las Vegas," he says. "At least you'll get free booze."

Another cause for skepticism: the perks that company principals get. In their IPO registrations, founders commonly report they've invested $25,000 altogether, paying between 1.5 cents and 3.5 cents a share. Also, many receive $90,000 a year to maintain an office as well as cover travel and other expenses. In many filings, execs state up front that they'll work no more than 10 hours a week for the startup.

Blank-check IPOs do promise more safeguards than they used to. After a string of shell companies fleeced stockholders in the late 1980s, the SEC ruled that any purchase must win approval of 80% of shareholders. Failing that, investors are owed refunds. That's true, too, if no deal is done within 18 months. Because their shares were offered at $5 and above, the latest issuers aren't covered by these rules. Still, in their filings, they generally agree to stick to them. That's probably the most anyone signing a blank check can hope for.

By Michael Arndt in Chicago

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