By Jamie Ho
SPACs have garnered a lot of attention in 2020, and their hype appears to be continuing into 2021. In the first part of the article, we provided a broad introduction of SPACs - What are SPACs, How do They Work, and What Makes Them so Special?
In the second part of the article, we will find out what is driving the rise of SPACs and whether its popularity is sustainable.
The Rise of SPACs
SPACs first emerged in the 90s. Back then, SPACs were shunned by mainstream investors, serving largely as a last resort to market for little known companies. Their sleazy reputation, lack of regulation, and association with penny-stock fraud schemes made investors wary of buying shares in companies listed via SPACs. Throughout the years, the volume of SPAC IPOs has tended to vary with the economic cycles, experiencing renewed interest in the early 2000s when Citibank became the first mainstream bank to work with SPACs. However, the fallout of the financial crisis–including increased business regulations and fewer businesses looking to go public–meant that the popularity of SPACs was short-lived.
SPACs are now once again experiencing a surge in popularity, but one unlike anything seen before (reference table below):
The volume and market share of SPAC IPOs have skyrocketed: In 2020, 248 SPAC IPOs raised over $83 billion in gross proceeds and accounted for 46% of the US IPO market. This is a 513% year-on-year increase in proceeds from 2019, when 59 SPAC IPOs raised $13.6 billion and accounted for 19% of the US IPO market.
Average SPAC IPO sizes are rising in comparison to traditional IPOs too: The average SPAC IPO size in 2020 was $336 million, larger than the average traditional IPO size of $213.3 million.
2021 has seen a continuation, even acceleration of SPAC’s rise. According to the FT, 61 new SPACs raised just under $17 billion in January 2021 alone, and as of April 2021, 308 SPAC IPOs have raised $99 million and contributed to 64% of the US IPO market. This marks a distinct and inexorable change in investor’s perceptions of SPACs.
Source: SPAC Analytics https://www.spacanalytics.com/
Recent years have witnessed not only record amounts of SPAC IPO volumes and money, but also the attraction of high profile sponsors, underwriters, investors, and deals:
Hedge fund manager Bill Ackman sponsored and raised $4 billion in his SPAC offering in July 2020, the largest ever.
Social Capital CEO Chamath Palihapitiya has launched 6 SPACs since 2019, acquiring companies like Richard Branson’s space company Virgin Galactic, real estate start up Opendoor, and Medicare insurance company Clover Health.
On top of getting big business from underwriting SPAC IPOs, banks like Goldman Sachs have even created their own SPACs: one which acquired data-centre equipment company Vertiv Holdings in 2020, and the other– GS Acquisition Holdings Corp II– which is still shopping for a deal.
Source: Bloomberg
But why have SPACs gained so much attention, and what is driving their popularity as the preferred method to go public?
Firstly, SPACs have gained renewed attention thanks to its rebranding. With the introduction of better shareholder protections and higher quality management teams, investors’ and companies’ perceptions of SPACs have improved. According to Deloitte, 45% of US corporate executives are interested in pursuing SPACs, while only 35% still view traditional M&A as worth considering. The entrance of reputable firms, finance titans, other high-profile sponsors, and high-profile deals have all helped build the credibility of SPACs and improve its legitimacy as a route to market:
The entrance of firms like Goldman Sachs, TPG, and Centerview.
The entrance of finance titans like Bill Ackman and Michael Klein.
The entrance of high-profile sponsors like former speaker of the House of Representatives Paul Ryan, activist investor Cliff Robbins, and former director of the National Economic Council Gary Cohen.
High-profile deals like DraftKings and Virgin Galactic.
Secondly, the pandemic has played a significant hand in boosting interest from investors. The pandemic has brought together stimulus packages, low interest rates and yields, as well as lockdowns to create monetary overhang and excessive liquidity, as people find themselves with lots of money and nowhere to spend it. This can be seen in the global stock market, which has rallied since March 2020 and created numerous bubbles. These macroeconomic conditions push people towards alternative investments, and SPACs provide the perfect opportunity for investors to access high reward investments with limited risks.
Lastly, pandemic uncertainty and market volatility has also increased the popularity of SPACs as a route to market. While the pandemic dwindled traditional IPOs, it accelerated SPAC IPOs. This is because the lengthy process of traditional IPOs makes it inherently risky– companies get very little visibility into the demand for, price of, or capital that will be raised from their shares till the very last minute, when the orders are finally put in. As a result, companies run the risk of spending time and money pursuing an IPO, only for it to fall apart when market conditions deteriorate. This uncertainty is amplified when the financial situations of the company, investors, and broader market can change dramatically due to pandemic-related effects.
In comparison, SPAC IPOs are very attractive, requiring much less time to complete with far more certainty in an increasingly volatile market. The detailed advantages of a SPAC IPO and De-SPAC acquisition when compared to traditional IPOs and RTOs can be found outlined in a previous article “Introduction to SPACs Part 1: What are SPACs, How do They Work, and What Makes Them so Special?” As the SPAC has already undergone its IPO, the administrative burden for the target company is far lower and they can usually go public in 2-3 months compared to the traditional 6-7 months. They also get to embark on this process under the guidance of an experienced partner, and with less worry about swings in market sentiment. SPAC IPOs also provide the target company with pricing visibility from the start, negotiating power, and certainty over fundraising and discounts.
The Risks and Rewards of SPACs
Fans of SPACs often point to the low risk, high reward of investing in SPACs, created by two unique attributes:
SPACs provide investors with the opportunity to cash out their shares at par plus interest should they not like the deal they’re presented with, or to redeem their shares should no deal occur.
SPACs tend to rally above their offering price prior to deal announcements, and again when an attractive merger partner is announced and viewed positively by the market. Investors can monetize on that, cashing out at that point and enjoying a potentially positive return while simultaneously hanging on to the warrants that can become extremely valuable if the takeover is well received.
Investors thereby have strong upside potential if a positively viewed merger occurs and the market rallies, as well as downside protection should an unsavoury deal, or no deal occur. This trade is incredibly popular amongst SPAC fans: Seen in a study of 47 SPACs, it was estimated that 58% of shares were redeemed at this point.
However, this seemingly straightforward trade has a number of caveats.
Firstly, not all deal announcements are viewed positively by the market, and a SPAC can trade down if it isn’t received well.
Secondly, SPACs don’t always have to give investors their cash back, with certain clauses that can halt redemptions should investors appear to be colluding to block a deal.
Thirdly, SPACs can spend years attempting to find a suitable target before finally liquidating. So although investors typically get their money back if a deal isn’t secured, this comes at the opportunity cost of being invested in the market.
Lastly, SPACs often underperform the market. This can be seen in a study of 56 SPACs that completed mergers since 2018, which found that they tended to underperform the S&P in the 4, 6, and 12 month periods following the acquisition.
For the target company merging with the SPAC, there are also hidden costs. SPAC’s share structures inherently cause stock dilution. SPAC sponsors typically own 20% of the SPAC at a heavy discount (i.e. the promote), which translates into a 1-5% stake in the target company. This means that sponsors make significant amounts of income so long as there is a deal, regardless of its quality. This not only incentivises sponsors to follow through with shoddy or pricey deals at the expense of the investor, but also costs the target company a large portion of equity. This dilution is compounded when investors cash out as in the trade described above. The redemptions drain money from the SPAC, while the sponsors and warrants still held by the redeemers swamp what little is left.
Lastly, we cannot ignore the lack of regulation and scrutiny that companies listed through SPACs enjoy, making them attractive lifelines to struggling companies. A study showed that between 2003-2013, 58% of companies that went public via SPAC failed. Negative press also tends to have an outsized impact on SPAC-listed companies, renewing concerns over SPACs and their cunning ability to circumvent the usual due diligence guardrails of traditional IPOs.
For example, electric vehicle company Nikola Corp managed to go public via a SPAC last year despite not earning any revenue in 2019. It then proceeded to have a scandal in September over its battery and hydrogen fuel cell claims, one which resulted in a fraud investigation by the SEC and the CEO’s resignation.
Despite these alarm bells, many fans remain confident that SPACs are safe, simply teasing out decent companies that might not otherwise list.
The Future
The recent explosion in SPAC supply means that SPACs have fewer attractive deals to pick from, and companies wishing to go public can shop around. As sponsors aren’t legally allowed to discuss mergers prior to their IPO, SPACs essentially go public blindly, not knowing if there will be significant demand to merge with them in the future.
This makes the possibility of SPAC supplies outpacing the number of companies willing to go public ever more likely. Further pressured by their 2-year time limit, sponsors may end up desperate, lowering their due diligence standards to pursue deals at the expense of investors. The more SPACs there are and the less due diligence being carried out, the more likely it is for investors to strike a bad deal. Plus, as more negative stories like Nikola’s pop up, investor caution surrounding SPACs may start to push people away from the structure.
As more and more investors jump on the SPAC bandwagon, compensation for getting involved at the IPO stage may also become less generous. This is already starting to happen, with some SPACs like Thoma Bravo Advantage (which targets software deals) raising $900 million without offering investors any of the warrants that uniquely characterises SPAC offerings.
That said, demand for SPACs may not run out just yet. As many fans argue, there could still be a large number of companies that are SPAC ready, just not IPO ready yet. International companies may also expand the field considerably. Although SPACs have always been and continue to be a largely American phenomenon– over 95% of SPACs in 2020 listed in the US–the acquisitions of target companies are not limited to American firms.
For example, despite being based in London and targeting British and European companies, Broadstone Acquisition Corp is listed on the NYSE. Other examples include former finance secretary of Hong Kong Anthony Leung’s SPAC, which listed in 2018 and raised $1.5 billion on the NYSE but bought a hospital chain in mainland China in 2019.
In conclusion, SPACs have experienced a huge surge in popularity these last 2 years, thanks to its unique qualities and driven by a self-affirming combination of rebranding efforts and market environments. That said, SPACs do hold a high amount of risk–risks that could undermine its sustained popularity into the future.
Jamie Ho
Jamie is a first year International Relations undergraduate at the London School of Economics. Her articles cover mainly markets and M&A, with a particular interest in political risk.
Disclaimer: This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice. Any investment involves the taking of substantial risks, including (but not limited to) complete loss of capital. You are advised to perform your own independent checks, research or study.