Special purpose acquisition companies (SPACs), also known as ‘blank cheque companies’, have experienced a meteoric rise in popularity this year. People as diverse as from former Republican House Speaker Paul Ryan and Hollywood executive Jeff Sagansky have been getting involved.
But with great popularity comes greater competition. Analysts have warned that this could be the downfall of some of the 170 such vehicles that have raised nearly $63bn in the US so far this year, according to SPAC Insider.
Before exploring the risks, it is worth explaining exactly what SPACs offer:
- SPACs are companies that have no operations and are formed with the sole purpose of acquiring a business;
- SPACs first raise capital through an initial public offering and then find a private company to acquire, thereby taking it public;
- Once a SPAC raises its capital through an IPO, it typically has two years to complete an acquisition or its sponsors must return the capital back to investors.
Sponsors, who are typically well-known executives and have included hedge fund billionaire Bill Ackman, can raise capital faster than a traditional IPO, and hold a 20% stake in the company that will be eventually acquired.
As target companies can go public faster and for investors, SPACs provide a way to participate in a private equity-like investment that is normally the reserve of the ultra-rich.
Rise in popularity
‘I think there has been a build-up of frustration among people looking for an alternative to traditional IPOs in the US,’ said Joel Rubinstein, a partner at law firm White & Case.
He said this is brought on by the amount of work the traditional IPO process requires, the length of time it takes for a company to actually go public and leaving money on the table, as IPOs don’t always deliver the best results.
Indeed, a study by Jay Ritter at the Warrington College of Business at the University of Florida found that over the last 10 years, venture capital-backed IPOs have been underpriced by up to 21% and left an average of $37m on the table.
Lise Buyer, founder and managing partner of consultancy Class V Group, added: ‘I think part of the reason [SPACs] gained popularity this year is they are a quicker way for a company to secure a public valuations, put money in the bank and begin trading.’
High-profile businesses that have been funded through SPACs in the last two years include Richard Branson’s Virgin Galactic Holdings, DraftKings and Nikola. While DraftKings and Virgin Galactic have been successes, Nikola has been plagued with allegations of fraud.
The electric and hydrogen powered semi-truck maker went public through a SPAC in June. The company also signed a major deal with General Motors, but short-selling firm Hindenburg called the company ‘an intricate fraud’.
Since then, the group’s chairman Trevor Milton stepped down and the company is reportedly being investigated by the Department of Justice and the Securities and Exchange Commission.
Too many SPACs, too few viable targets
Many of the targets of SPACs are speculative businesses and the pool of quality companies that are ready to go public are dwindling.
‘At this point it appears like there are more SPACs than there are companies that are truly ready to be reverse merged and emerge as stand-alone companies,’ said Buyer, who was one of the chief architects of Google’s IPO.
‘When you look at the terms of the most recent SPACs as compared to the ones from two months ago - those were pretty rough on the companies being acquired. Now there are so many SPACs out there, companies can pick and choose the ones with the better terms,’ she added.
The problem is worsened, she explained, if a SPAC is getting close to its acquisition deadline but still doesn’t have a target.
‘The pressure is then really on to just buy something,’ she said. ‘One would hope they would just return the money but that’s probably really unlikely.
‘One could theorise that the quality of the companies being acquired declines in relationship to how many months the SPAC [is in operation]. A desperate shopper might find something someone who has more time might not want.’
As the market has gained traction, ETF providers have also been looking to take advantage.
The Defiance NextGen SPAC Derived ETF launched on 30 September, with the explanation that ‘the ETF structure allows investors to access the most liquid SPAC IPOs in a diversified basket’.
The ETF claims to ‘empower’ both financial advisers and retail investors to participate in an IPO private equity style of investing. The ETF has $21.5m in assets so far, and has returned -11.43% since inception, according to its website.
Cameron McVie, head of relative value strategies at Russell Investments has warned that this could be ‘quite a risky proposition’ in a recent blog post, noting that the group believes ‘active managers are key to generating positive excess returns in speculative companies’.
He added: ‘Although some de-SPAC deals have been quite successful, the post-merger performance of companies has been mixed, with a wide dispersion of outcomes. On average, SPAC transactions underperform broader equity markets in the subsequent years.’
A Goldman Sachs report published in July found that in 56 completed transactions since January 2018, SPACs on average initially outperformed the broader equity market, but then registered significant underperformance over the subsequent three, six, and twelve months.
US vs Europe
While the flurry of listings continue in the US, the European markets have not seen a similar level of activity. In fact, according to Dealogic, there were no SPAC listings recorded so far this year in Europe.
White & Case’s Rubinstein said there are structural impediments that have resulted in a drought of listings on European exchanges.
For example, in the UK, shareholders don’t get a vote on the acquisition and they don’t have the ability to redeem their shares if they do not want to invest in a specific target – which is the opposite in the US and makes fundraising more difficult as it is seen as less investor-friendly.
In addition, when the acquisition takes place, the company’s shares are suspended until a deal prospectus is published, which locks in investors, who might want to sell, for a longer period.
According to the Financial Times, the London Stock Exchange is exploring how to attract blank cheque companies.
Jon Parry, a partner in White & Case’s capital markets group in London, told Citywire that there is no regulatory reason why SPACs can’t have redemption rights or allow investors to vote on the acquisition target.
Therefore he believes ‘there might be a misconception that regulators and exchanges can tweak the rules and then we’ll suddenly have a spike in activity’. While he expects an increased focus on changing the suspension requirements in the UK, it will not suddenly kick-start a SPAC boom.
‘I think in EMEA, I can’t see activity levels reaching the heights they have done in the US. But I do think that if 2021 becomes bit more conducive to public market activity generally, and if the outcome of events [like the US election and Brexit] create a more benign environment, there will generally be more public market activity and I think SPACs will be more central in terms of they have been.’