Previously published in The Digital CFO magazine (Winter 2023)
If you were a consumer of business news in 2020 and 2021, it was hard to go too long without reading about the significant rise in SPACs, or special purpose acquisition companies. Today, that flood has slowed to a trickle. Here’s a quick look back at the past, an assessment of the present and a peek into the future of this IPO vehicle.
SPACs have been around since the 90s and are essentially big pools of cash listed on an exchange. Their purpose is to find a private company, buy it and take it public quickly. Some on Wall Street call them “blank-check companies’’ because the investors backing the SPAC put up their money months before an acquisition target is identified, trusting the people running the show to find a good deal.
The shares of these companies are issued at a nominal $10/share to shareholders. There is no incentive for a shareholder to own a SPAC share since there are no assets on the book besides the cash raised. The shareholder is betting on the optionality of the SPAC to find a deal that is worth more than the nominal value – essentially an arbitrage play.
In 2020 and 2021, many shareholders found that the hype behind a deal was enough to create an arbitrage opportunity and oftentimes bought into shares at much higher than the nominal value, creating a bit of a frenzy to raise a deal. Typically a company has 2 years to secure a deal and shareholders have several opportunities to pull back their funds. This can put a constraint on what kind of deals the SPAC can reasonably afford to fund.
In a counterparty to all this, there is the target acquisition company. This company may or may not have a traditional path to an IPO and many private investors look to SPACs as a liquidation event for an investment that may be giving a negative return to date. Historically, these companies were often left for dead by traditional IPO markets, but 2018-2020 saw some successful deals, triggering an entire boom cycle of funds.
To put things in perspective, 2019 to 2020 showed a 462% year-over-year jump in proceeds raised by SPACs. In 2021 this trend continued with IPOs (including SPACs) enjoying a record year with 2,340 new issues raising $428.9B. (by volume, IPO activity rose 73% compared to 2020.)
With that context in place, where are we today? Like many things in life that have a limited purpose, excess can be self-sabotaging. Of the roughly 600 SPACs still out there scrambling to find targets before the market shuts down entirely, 270 have been looking for at least a year, according to Dealogic.
Backers of those companies are desperate, which could make them less judicious in choosing merger partners, said Nathan Anderson of Hindenburg Research, a firm that specializes in publishing critical reports about publicly traded companies including SPACs.
“The quality of SPAC deals was never high to begin with,” Mr. Anderson said. “And now it has the potential to get substantially worse.”
2019 to 2020 showed a 462% year-over-year jump in proceeds raised by SPACs. In 2021 this trend continued with IPOs (including SPACs) enjoying a record year with 2,340 new issues raising $428.9B. (by volume, IPO activity rose 73% compared to 2020.)
In December 2022 alone, Roughly 70 special-purpose acquisition companies liquidated and returned money to investors. That is more than the total number of SPAC liquidations in the market’s history, according to data provider SPAC Research. Data shows that SPAC creators have lost more than $600 million on liquidations this month and more than $1.1 billion this year.
Those SPACs that came late to the game are often struggling to find deals. Falling stock prices and rising interest rates have essentially frozen the market for new public listings, making it difficult for executives to meet their two-year deadline to find a deal. Many of those deadlines are coming up in the first half of this year.
Besides the deadlines, a new tax treatment on SPACs led many to liquidate prior to 2023 to avoid a new share repurchase tax, which would impact any liquidation process.
Research on returns have shown that SPACs ultimately do create risk for sponsors and investors in what was thought to be a relatively risk free alternative investment. After all, how could you lose money investing in cash? Several SPACs are trading below the $10 nominal price, and a recently updated paper by Minmo Gahng, Jay R. Ritter and Donghang Zhang shows that average one-year returns for SPAC shareholders who rolled their money into post-SPAC companies were a negative 11.3%.
With so many returns in the red, and liquidations occurring left and right, who ultimately benefited?
For one, the companies getting overvalued. Mostly, though, it was those investors who held shares between the SPAC’s listing and merger, who made annualized returns of 23.9% for little risk. As an earlier paper shows, virtually all initial SPAC investors, mostly hedge funds, leave by the time deals close.
“You basically need to re-raise all of the money at the time of the merger, so what’s the point of raising it initially?” said one of its authors, NYU School of Law Professor Michael Ohlrogge. “You subject the deal structure to needless risk.”
With more data on SPACs, a group of investors who have gotten burned and society returning to a post-pandemic normal, there is less motivation to pile into a SPAC as a hype vehicle. Celebrities are no longer putting their names behind it and the number of SPACs on the market looking for a deal has dried up.
That doesn’t necessarily mean that there isn’t a place for SPACs in the future, however the deal structure likely needs to evolve for it to be a meaningful option for many companies going public. With up to 80% of shareholders seeking their money back, the post-merger company simply does not have a stable source of funding to move forward. Given the competing interests and time constraints, there may be some merger targets identified, however, the majority of the funds are likely to be liquidated or returned at face value to investors.
SPACs could be reformed. London’s nascent market hopes to prove they can help forge long-term partnerships between sponsors and firms. Hedge-fund guru Bill Ackman is promoting a new type of vehicle designed for investors to opt in only after a target has been found. Some, such as RA Capital Management, suggest adapting IPOs to incorporate some of the advantages of SPACs, such as greater upfront share-price certainty.
As they currently stand, however, SPACs only seem to serve speculators, not the venture capitalists’ talent-spotting entrepreneurs nor the long-term investors buying into companies. Perhaps the clock should run out on them for good.
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