“It’s never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it’s a good investment.“
Although special purpose acquisition companies (SPACs) have been around for decades, they have attracted unprecedented interest and investment since the first wave of the COVID-19 pandemic. Amid this recent boom, entrepreneur Richard Branson, retired baseball star Alex Rodriguez and other celebrities have sponsored their own SPACs.
But all this hype has come with considerable controversy and added regulatory scrutiny. And for good reason. SPAC-related excesses have been well documented and have raised questions about the underlying suitability of these investment vehicles. The SEC’s admonition, cited above, indicates the credulity with which some approached the recent SPAC bubble.
So what is a SPAC? How it works? Who are the players? What are the risks and opportunities? And is the recent SPAC surge a one-time flash in the pan or something more lasting?
What is a SPAC?
A SPAC, or “blank check company,” is a publicly traded corporation created to facilitate a merger, acquisition, or “combination” to take a private company public. The SPAC has a built-in time limit, usually two years, in which a transaction involving at least 80% of the initial investment can be consummated, otherwise the capital is returned to investors.
SPACs raise money in the same way as other publicly traded companies and initial public offerings (IPOs), through public equity investment, among other sources and mechanisms, including public private equity investment (PIPE).
To bring a SPAC to market, the management team creates the blank check company to register with the SEC, publicly trade on a national stock exchange, and raise capital. That capital is then held in trust while the management team identifies potential private companies to acquire. When this identification phase is complete and the target selected, the SPAC will deploy its capital to acquire or merge with that company, thereby making the target public in what is commonly referred to as a “de-SPAC” transaction. “.
Although SPACs have long been overshadowed by IPOs, SPAC investments have skyrocketed in recent years, from $13 billion in 2019 to $96 billion in the first quarter of 2021 alone. year 2021 saw a grand total of 679 SPAC IPOs worldwide for a combined value of $172.2 billion. At one point, there were actually more SPAC offerings than IPOs.
Why SPACs?
Despite their hype and grandeur, IPOs present significant barriers to entry. They require considerable time and cost to complete and their post-market challenges and regulatory burdens can make them impractical. Successive waves of the pandemic, with their supply chain disruptions and associated market volatility, have further exacerbated the downsides of the IPO market.
Meanwhile, as central banks have pumped capital into the economy and cut interest rates to stave off a pandemic-induced global recession, investors have been desperate for yield, and some have seen SPACs as a faster, cheaper alternative. less arduous in going public.
The good . . .
Compared to traditional IPOs, SPACs have much shorter turnaround times and are typically less expensive to facilitate. This apparently gives SPAC investors and managers more agility to strike while the iron is hot. Opportunities and their benefits can materialize in a much shorter time horizon (approximately six months) compared to traditional IPOs, which can take years to bring to market.
SPACs also provide faster access to public funding and a quicker exit for those looking to cash out, while avoiding the traditional dog-and-pony exposure to the stock market. The SPAC process can also reduce price volatility because a binding valuation is agreed upon and approved by interested parties before the merger takes place, in contrast to a traditional IPO where the underwriters typically guide the valuation process.
SPACs have proven to be particularly lucrative for owners of private companies that go public, as well as for SPAC sponsors. SPAC investors, however, have not always fared so well.
The bad and the ugly
Several studies of SPAC performance over the past several years indicate that SPAC sponsors and the founders of the acquired company reap most of the profits. Investors who finance the projects usually receive much less than they put in. Despite its supposed simplicity, investing in SPACs is more complicated than investing money and getting more back.
The deflation of the SPAC bubble and associated scandals have created a more cautious environment among investors and led to increased oversight by investor groups and regulatory bodies. The SEC has stepped in to clarify how SPACs operate, and disappointing SPAC filings have spurred investigations and class-action lawsuits.
All of this means that investors should exercise due diligence and approach SPACs with caution.
Other challenges to consider
- SPACs do not operate: IPOs can vaporize a company’s liquidity along with interest from institutional investors and the general public. On the other hand, IPOs can also send the stock price skyrocketing. SPACs cannot be raised in the same way. Because the price is pre-negotiated, they have a lower ceiling, but also, theoretically, a higher floor.
- Things will fall apart: As buyouts, SPACs are prone to short circuits. Anything from legal liabilities and taxes to HR issues can derail a deal after months of negotiation. Uncertainty is a fact.
- “Public” Scrutiny: A company’s transition from private to public investment entails new disclosure requirements and new processes that could undermine the nature of the business. The cultural and regulatory environment in which a SPAC acquiree operates can also change overnight as it goes public. This increases the risk of employee turnover at all levels.
- Misaligned goals: SPAC management teams may not have experience in their target company’s market segment. This can lead to conflicts between SPAC sponsors and the owners of the company they are acquiring.
- Separating the good from the bad: The market is more demanding about SPAC quality today than before in the boom. Thus, SPAC sponsors will need to demonstrate the quality of their business to potential investors.
- commissions: Many advisors punch their tickets up the SPAC food chain, from SPAC promoters to SPAC underwriters to de-SPAC advisors and more.
- After market trading: Nothing drives the market for new de-SPAC transactions like trading after completed transactions. And as we enter 2022, the trailing trading performance of SPACs is in steep negative territory, amid the paltry aftermarket trading performance of traditional IPOs.
- Clogged pipes: SPACs typically acquire companies valued at many multiples of their cash in trust. This requires the successful execution of a concurrent PIPE. But the PIPE market is clogged and there is no plumber in sight. As a result, many SPACs are set up to expire, as a de-SPAC transaction cannot be completed without a PIPE.
Moving beyond the hype?
Since the boom and bust of the recent SPAC hype cycle appears to have run its course, now may be a good time for investors to reevaluate these investment vehicles. Its luster has dimmed considerably and this may allow for a better and more accurate assessment of its potential value, especially amid the resurgence of inflation, a stock market correction and higher interest rates on the horizon.
For their part, SPAC sponsors need to up their game. They need to identify more realistic goals and set more reasonable expectations.
Excesses aside, with their nimble structure and faster turnaround, SPACs should be attractive to both investors and company founders and backers.
They might be worth another look. A long and careful look.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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Sameer S. Somal, CFA
Luis Lehot
