18 March 2021
“Anyone who’s anyone has a SPAC right now”…
That was the lead of a recent New York Times article, documenting the rapid rise of Special Purpose Acquisition Companies (or “SPACs”). The article pictured an array of glamorous celebrities, politicians and sports stars who are all involved in SPACs. Think Jay-Z, Paul Ryan and Serena Williams – not the most obvious of people to be involved in the promotion of financial shell corporations.
But these promotional activities have certainly done the trick.
2020 was a surprisingly good year for IPOs, with 480 companies moving from private to public ownership on US stock markets – over double the average seen over the last five years.
What gets really interesting is that the majority of those newly listed companies were actually via SPACs. Although SPACs have existed for many decades, we are now witnessing a modern-day SPAC revolution, with US markets leading the charge – perhaps “Super-Popular Acquisition Companies” is a more apt title.
Depending on who you listen to, SPACs could be the future, evidence of a dangerous speculative bubble or just a temporary distraction but the real issue is this: whilst they may be an effective way for small and medium-sized companies to access capital and the SPACs themselves will be enjoying their flurry of mergers and acquisitions, do they offer good value for money for investors?
What is a SPAC?
In simple terms, a SPAC is a listed company with no commercial operations that exist purely to raise capital from investors and to use that capital to acquire privately-held companies and to help those companies grow through investment in the business, increasing brand awareness and/or acquisition and then ultimately to take the business public. SPACs have two years to complete a transaction, else they must return the raised funds to investors.
Although a SPAC itself may appear unfamiliar, you will have heard of some of the companies that have been acquired by them, which include: Virgin Galactic (space tourism), the sports entertainer DraftKings and the healthcare technology company CloverHealth.
Why not just IPO?
The “traditional” route by which a company transitions from private to public ownership is via an Initial Public Offering (“IPO”).
However, there are downsides to this route, including:
- Misaligned outcomes - The biggest complaint against IPOs is that much of the value unlocked by taking the company public goes to investment bankers and the clients of asset managers, rather than the owners of the company. Many commentators consider that banks underprice offerings in order to reward their customers with an initial stock price “pop,” which will help lure them into buying less attractive offerings in the future. Each of AirBnB, Doordash and C3.ai (which all went public via a “traditional” IPO in late 2020) saw significant increases in the price of shares at close on their first-day trading bringing into question the initial offering price.
Banks also charge handsome fees to conduct the offering. Taken together, the offering discount and fees can add up to a 40% initial cost of capital, according to some industry observers.
- Governance burden: An IPO is subject to a high level of regulation. It is a lengthy process and beholden to banker timelines – the IPO market by and large shut down at the height of the Covid-19 pandemic.
- Restrictions on what can be disclosed – generally, a company looking to IPO is prohibited from including forward-looking financial projections in its prospectus. This makes it challenging for companies that have a “complex story” to share with potential investors to obtain a price that reflects their true value.
Until very recently, the above had all contributed to a declining trend in IPO activity, with far fewer companies going public than 20-30 years ago. This has meant that those investors who aren’t able to access private markets have been shut out of many exciting opportunities.
Why have SPACs grown in popularity?
Many of the shortcomings associated with IPOs are addressed by SPACs. Bankers play a much less central role, and the SPAC process is faster.
But such a meteoric rise of SPACs cannot be explained by these factors alone. As shown in the chart below, it is estimated that SPACs represented more than 50% of IPO capital raised in 2020, compared to less than 25% a year ago, and less than 5% only 4 years ago.
Source: JP Morgan Asset Management, Pitchbook, SPACInsider, SPAC Data
A key driver of the rise in SPACs seems to be the fact that high-profile individuals have gotten involved with them, not because they are a novel approach.
Should institutional investors care?
The SPAC market in the UK is minimal compared to the US, due to regulation. However, recommendations from a recent post-Brexit review, look set to make the regulatory environment in the UK more accommodating to SPACs. Many promising UK start-ups, such as Babylon Health, are being courted by sponsors of US-based SPACs. A change in UK regulation could pave the way for the market to grow, which would be a boon for a UK government desperate to protect London’s reputation as a powerhouse in global markets, in the post-Brexit world, and ensure that promising UK tech companies aren’t lured away to list on foreign markets.
But, for all their hype, SPACs are certainly not a panacea when viewed from the perspective of potential investors:
- Historically, SPACs haven’t delivered great returns for investors. In fact, not long ago they were considered to be a last resort when it came to raising capital. A recent paper by US academics showed that on average SPACs returned -34.9% 12 months post-merger, partly due to their opaque cost structures.1 It is too early to tell whether this trend will be reversed by this most recent crop of SPACs.
- Some of their major selling points are also reasons why the unwary may be caught out. SPACs are often referred to as “blank cheque” companies, so investors do not necessarily know at the outset what they are getting into. And because of the looser disclosure requirements, promoters of SPACs are much freer to spin whatever tale suits them best.
SPACs represent an alternative, and simpler method for private companies to go public – that should be seen as a boon for the global economy. If nothing else this means that private markets investors now have an additional viable exit route (welcome news to the holders of both private equity, and investors in opportunistic debt funds), and public markets investors now get ready access to opportunities not previously open to them. In a world where fewer companies are choosing to go public, this is good news for investors.
If you are a global equity investor, you may already find exposures within your portfolios to companies that have only become accessible thanks to a SPAC.
However, the rise in SPACs transactions (“SPAC-tivity”) over such a short period indicates a need for caution – there are certainly signs of exuberance in the SPAC market, and their connection with celebrity and popular culture makes them an easy target for criticism. But for an investor, we would say that this is a reason to become informed and to “watch this space” carefully rather than dismiss them as a fad.
1. A Sober Look at SPACs, Michael Klausner, Michael Ohlrogge, Emily Ruan, 28 October 2020