SPACs are Booming

There has been a sudden and substantial surge in SPAC activity over the last 6-12 months, so much so that they have the potential to outpace traditional IPOs this year and perhaps become the hottest asset class in US equity markets.

SPACs are capturing the “greatest wealth creation opportunity in history” and are “a better path than an IPO” – Vivek Ranadivé (Billionaire Silicon Valley Investor)

What are SPACs?

Commonly referred to as "blank-check companies', a special purpose acquisition company (SPAC) is a corporation formed to raise capital through an initial public offering (IPO) with the sole intention of acquiring or merging with an existing company. SPACs do not have any commercial operations. The reason for their nickname (blank-check) is because investors do not know the identity of the company that the SPAC will look to acquire. They may have an idea about the industry in most cases but the funds will are essentially used for the SPAC owner to go shopping for companies.

Since SPACs are only shell corporations and do not have any commercial operations, the founders become the selling point when raising funds. The money raised in an IPO is placed in an interest-bearing trust account and the founder(s) then have up to 24 months to merge with a company. If the deal is confirmed then the privately held company will go public via a reverse merger. In the case that no deal is complete then the SPAC is liquidated and funds are returned to investors.

SPAC Attack

Source: Bloomberg

Source: Financial Times

SPAC Facts

– Less than two weeks have gone by since Bloomberg published the graph above (August 15) and the numbers on SPACs continue to soar. As it stands, there have been 74 SPACs that account for more than $28bn of the $72bn raised in IPOs on US exchanges this year, more than doubling their total from all of 2019, which was also a record year.

(edit: Bloomberg reported on 27 August that more than 40% of 2020's IPOs by volume have been SPACs, raising $31.6bn)

– Finance and tech titans like Bill Ackman and Kevin Hartz, along with activist investor Cliff Robbins have all recently raised capital for SPACs. They have even attracted big wall street names like Credit Suisse, Centerview Partners and Goldman Sachs.

– Since 2017, Goldman Sachs has ranked amongst the top 5 SPAC underwriters. Goldman's involvement goes further because they have launched two of their own shell companies. The first merged with Vertiv (digital infrastructure company) earlier this year, after raising $600m in 2018. The second raised $700m in June.

– Michael Klein's SPAC, Churchhill Capital Corp III, raised $1bn in February to become the largest SPAC ever. Only to be surpassed several months later by Bill Ackman's SPAC, Pershing Square, which recently raised $4bn in hopes of acquiring a unicorn startup.

– More than half of SPACs have found merger targets:

Source: Financial Times

Why the sudden surge?

SPACs have surged as an alternative avenue for companies to raise capital from the public markets. Privately held firms are choosing SPACs because they offer fewer regulatory obstacles than traditional IPOs and gain access to public markets easier and faster, with greater certainty of the price they can attain. This is partly because, unlike traditional IPOs, SPACs do not require roadshows. Coincidingly, the extreme market volatility amid the pandemic concerns means that the potential amount of capital raised in traditional IPOs could be entirely different depending on the day. Whereas SPACs are generally less impacted by swings in broader market sentiment.

Further, the appeal for investors is that it is viewed as an essentially risk-free investment. Money is put into a SPAC, which then sits in what is effectively a trust that yields interest. Investors can also choose to either approve or oppose the deal, in which case the money invested is returned.

SPACs are also gaining interest from Investment Banks because they are collating significant fees. While market uncertainties have depressed expectations for IPOs this year, SPACs have already generated $800m in fees. As shown earlier (in the SPAC facts section), Investment Banks like Goldman Sachs are also launching their own SPACs. This involvement from large, reputable institutions is also influencing the dynamics of the market, as well as altering investor perceptions.

Source: Bloomberg

What's the Catch?

SPACs are not without risk and many pursue deals that fail to yield returns. There are also numerous sceptics emphasising that SPACs still sustain a reputation for targeting underperforming businesses and providing companies that would generally have trouble completing a traditional IPO with backdoor entrance to public markets.

Performance Comparison: since 2010, SPACs have returned 10% on average. Within this same timeframe, the S&P 500 has substantially outpaced SPACs and returned 203%. Historical data on SPACs have negatively portrayed its post-IPO performance. Concurrently, SPACs faced intense scrutiny as it was commonly associated with bad acquisitions, poor management and ways for fraudulent financiers to unload dodgy businesses on the unsuspecting masses. This led to a steep downturn in activity after 2007, with less than 10 transactions taking place over a 2 year period (2009-2010).

Yet, despite a history of poor post-IPO performance, SPACs are booming. One factor that has had an altering influence on the dynamics of the market is that institutional and reputable investors are now starting to embrace the product, which has not been the case historically. This shift in the quality of sponsors and introduction of investor-friendly regulations has now made investors ever more comfortable with the economics of SPACs. So, it is important to consider that times have changed quite drastically over a decade and in certain cases, historical data may not be entirely applicable to the current environment.

The Outlook?

At the moment, the combination of a much higher quality group of SPAC sponsors and a potential set of solutions to a company is generating a lot of attention for this product. Further, due to the impact of the pandemic, private firms are seeking easy and quick access to finance. It is also in these times of heightened market volatility that companies are enticed by the SPACs ability to fix a price and execute deals quickly whilst simultaneously avoiding delays and regulatory hassle associated with traditional listings.

However, whilst dialogue is active currently, there is strong debate as to whether this surge is a bubble and will discontinue once markets become less volatile. With regards to SPAC issuance, there is reportedly a large pipeline of high-quality sponsors seeking to issue SPACs. So with this shift in the quality of the sponsors, a strong pace of business combinations via SPACs will likely continue. This is because there are many companies trying to access public markets, so having this additional tool will help continue this pace.

Exchanges at Goldman Sachs have highlighted that, given its sudden popularity, investors and clients are now inquiring to understand how the processes and structure of SPACs work. This alludes to the likelihood that this focus on the SPAC market will continue. Overall, it is crucial to observe the progress and success of these deals as to whether they continue to trade well. Due to its infamous past, it is likely that any issues will lead to hindering investors' perception of these transactions.