SPACs - a boom or a bust

SPACs, or special purpose acquisition companies, are arguably one of the hottest asset class in the US of late. Once shunned by investors, SPACs, aka blank check companies, have become an increasingly popular method in recent years to list companies on a stock exchange.

SPACs are shell companies without any commercial operations but are created solely for raising capital through an initial public offering (IPO) by acquiring a private company. This is done by selling common stock with shares commonly sold at usually $10 apiece and a warrant, which gives investors the right to buy more stock at a later date at a fixed price. Once the funds are raised, they are kept in a trust until the management of the SPAC (also known as sponsors) identify a company of interest, which will then be taken public through an acquisition, using the capital raised in the IPO. If the SPAC fails to merge or acquire any company within the set deadline (mostly two years), the SPAC will be liquidated, and investors would get their money back.

The structure of SPACs allows investors to contribute money towards a fund without any knowledge of how their capital will be used, hence the term ‘blank-check companies’. But what’s the difference between a SPAC IPO, and a traditional one? There are several ways a private company can go public. The most common route is through a traditional IPO, where it’s subject to regulatory and investor scrutiny of its audited financial statements. An investment bank is usually hired by the company to underwrite the IPO, which usually takes 4-6 months to complete. This involves roadshows and pitch meetings between company executives and potential investors to drum up interest and demand in its shares. And not all IPOs succeed. Co-working-space company WeWork withdrew its high-profile IPO in 2019 amid weak demand for its shares after massive losses and leadership controversies were revealed. Other companies such as Spotify and Slack went public through direct listings, saving on fees paid to middlemen such as investment banks, although there are more risks involved. And while private companies listed through SPACs are similar to reverse takeovers. Because SPACs are nothing more but shell companies, their track records depend on the reputation of the management teams.

By skipping the roadshow process, SPAC IPOs also typically list in a much shorter time. This has led some investors to become wary of buying shares in companies listed through SPACs due to the lack of scrutiny compared to traditional IPOs. SPAC sponsors also typically receive 20% of founder shares in the company at a heavily discounted price, also known as the “promote.”

This essentially dilutes the ownership of public shareholders. But how have SPACs fared in equity markets, especially for ordinary investors? A study of 56 SPACs that completed acquisitions or mergers since the start of 2018 found that they tend to underperform the S&P 500 during a three, six and 12-month period after the transaction. A separate study of blank-check companies in the US organized between 2015 and 2019 found that the majority are trading below the standard price of $10 per share. Between 2017 and the middle of 2019, there were 100+ SPACs in the US, with an average return of a mere 2%.

If there’s one thing that markets hate, that’s uncertainty. Even before the pandemic, SPACs were already on the rise, buoyed by the equity boom and hot IPO market in 2019. While the pandemic has slowed the pipeline of traditional IPOs, SPACs have bucked the trend. With the quality of management teams improving, fewer disclosure requirements and a relatively straightforward listing process, blank check companies are booming. In fact, funds raised through SPACs outpaced traditional IPOs in August — a rarity on Wall Street. In the first ten months of 2020, there were 165 SPACs IPOs globally, of which 96% of them were listed in the US. That is nearly double the number of global SPACs issued in 2019 and five times that of 2015. Of the $56 billion poured into global SPAC listings in 2020, 99% was raised in the US, and that figure is nearly 12 times the amount raised globally in 2015 over the same period.

While largely an American phenomenon, SPACs have caught the attention of investors in other jurisdictions. In 2018, Antony Leung, the former finance secretary of Hong Kong, raised $1.5 billion on the New York Stock Exchange through his SPAC, which bought a mainland hospital chain a year later. Other players include Masayoshi Son’s SoftBank, and the investment arm of Chinese state-owned conglomerate CITIC Group. Despite having sponsors from Asia looking to acquire international companies, these SPACs are ultimately listed in the US. It’s a similar story in Europe, which has seen muted SPAC activity. For example, the management team of blank check company Broadstone Acquisition Corp is based in London, targeting private companies in the UK and Europe, but is listed on the New York Stock Exchange. One main reason is the different rules for SPACs across jurisdictions. In the US, investors can vote to approve the acquisition the SPAC proposes, or redeem their funds if they do not support the proposed deal. This, however, isn’t a requirement in some European jurisdictions, including the UK. There is also a lock-in period for British investors once an acquisition is announced until the approval of the prospectus, which ties them into deals that they may not support in that indefinite period.

But changes may be afoot. As SPAC activity reaches fever pitch in the US, regulators are putting these blank check companies under the microscope. Competition to the IPO process is probably a good thing, but for good competition and good decision-making, you need good information. And one of the areas in the SPAC space that particularly needs attention is incentives and compensation to the SPAC sponsors. However, some SPAC proponents have defended SPACs transactions, saying that they are no different from the fees that banks collect in a traditional IPO process. As more ordinary investors jump on the SPAC bandwagon, experts are concerned that this will overheat markets and affect any fragile economic recovery. While SPACs provide a straightforward route to invest through a trusted intermediary, its performance so far means that it is a dicey bet for ordinary investors.

Sources: Bloomberg, CNBC, TechCrunch

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