SPACs as Alternative Investment: A Critical Review
The present SPAC ecosystem
SPACs are corporations formed purely to raise funds via an IPO and merge with private enterprises. Firms can obtain public market liquidity by combining with a SPAC sponsor. The SPAC proceeds broadly take place across 3 stages: the SPAC is formed and goes public; the SPAC identifies and acquires the target company; the SPAC merges with the acquired target and takes this company public. The growth of SPAC proceeds has been tremendous in recent years, it has grown by 94% to $161 Bn in the year 2021 as compared to $83 Bn in 2020. High-profile names such as 23andMe, Taboola, and BuzzFeed each recently went public via SPAC. Then there’s this remarkable fact that SPACs accounted for 50% of all new publicly traded firms in the US in 2020. However, in 2021, the financial performance of all SPACs has declined.
In 2021, there are 606 SPAC filings, with an average IPO size of $266.5 Mn, down from $336 Mn the previous year. This demonstrates that once targets are specified, the majority of SPAC investors withdraw. According to the researchers, the average percentage of redemption per contract among the SPACs evaluated was 58%, with a median redemption rate of 73%.
Beyond the US, the SPAC craze has failed to gain traction, as there is a smaller desire for foreign businesses to go public via SPAC. Few Asian stock exchanges allow SPACs, and SPACs in Europe are treading carefully due to increased regulatory scrutiny. As the Covid-19 crisis continues to create uncertainty in the IPO market, more private firms are looking for exit possibilities.
Why are companies getting involved in the SPAC craze?
An IPO is often used to acquire funds, provide shareholder liquidity, promote brand recognition, and gather resources to help a company grow. To achieve these objectives, firms across all industries are increasingly pursuing mergers with SPACs rather than acquiring a standard IPO. Small and midsized companies may wish to continue investing in growth, brand recognition, or acquisitions to expand, but they may not be good candidates for typical IPOs. Existing enterprises can keep a share in their business and obtain access to funding that would otherwise be unavailable to them by merging with a SPAC sponsor. As a result, more big private equity companies, venture capital funds, and operators create SPACs, this trend is expected to continue.
SPACs attracted established hedge funds, private equity, and venture capital firms, as well as top operations executives. It can be observed from figure 1, In 2019, 59 were created with a total investment of $13.6 Bn; in 2020, 248 were created with an investment of $83 Bn; and till the fourth quarter of 2021, 606 were created with a total investment of $161 Bn.
SPACs have been around for decades, but blue-chip investors have just recently been interested in them. When SPACs first debuted as blank-check corporations in the 1980s, they were poorly regulated, and as a result, they were plagued with penny-stock fraud, which cost investors more than $2 Bn per year by the early 1990s. But since then, a slew of regulations have changed, and blank-check corporations have been renamed as SPACs under a new legal framework. They tended to concentrate on distressed firms or specialty sectors, which reflected the available investment options at the time. That began to change in 2020 when a large number of serious investors began creating SPACs in large numbers.
Fig. 1: SPAC IPO Deal Count by Year
From January 2020 through the first quarter of 2021, post-merger SPACs outperformed the S&P 500 by a large margin, rising 47% as compared to 20%. Stocks in SPACs with an announced agreement but no merger as of March 2021 are risen 15% on average since IPO, compared to 5% for the S&P 500 during the same period. SPACs are appealing because they allow target companies to go public easily without the volatility of a typical initial public offering, while investors have access to high-reward investments with low risk.
Downsides of going Public via SPAC
SPAC issuance has recovered, but stock performance has not. Meanwhile, SPAC redemptions have been increasing as investor enthusiasm has waned. According to a study published in the Yale Journal on Regulation, a key element of modern SPACs is the option for investors to exit a deal after the sponsor has identified a target and announced a proposed merger. If investors don’t like the agreement, they can opt out and have their shares redeemed for the money they put in plus interest.
The SPAC frenzy screeched to a halt in 2021. From figure 2, the shell companies that have listed shares i.e., SPAC filing is 606 in 2021 with an average IPO size of 266.5 Mn, 26% less than the previous year’s 336 Mn. Those figures don’t inspire confidence at first look, since they show that most SPAC investors are pulling out once targets are identified. However, a closer examination of the data revealed that several of the SPACs raised relatively modest amounts of money and gave higher-than-average warrants as an incentive to draw investors, both of which are indicators of lower-quality sponsor teams. The average percentage of redemption per contract among the SPACs studied was 58%, with a median redemption rate of 73%, according to the researchers. Not only that, but over 90% of investors withdrew out of more than a third of the SPACs. From July 2020 to March 2021, the average redemption rate for the 70 SPACs that found a target was barely 24%, equating to 20% of the total money invested. Over 80% of SPACs saw redemptions of less than 5%.
Fig. 2: SPAC IPO Count and Average IPO Size by Year
They consistently underperform traditional IPOs, according to the research. SPACs that went on to combine with businesses had risen by an average of 11% since their initial public offerings. However, that is a generous view of them. These equities have dropped 9.9% on average since the mergers took occurred. Many high-profile corporations turned down the SPAC option, preferring to go public the old-fashioned way. For example, Airbnb was reportedly approached by Bill Ackman’s $4 Bn SPAC, but the business chose to go the traditional IPO route instead, debuting in Dec 2020.
SPACs do not appear to be less expensive than typical IPOs, contrary to popular opinion. They pay a fee of roughly 5–6% of the amount raised to underwriters and institutional investors, and they provide the creator up to 20% of the shares for free. SPACs aren’t any cheaper than IPOs today, even after accounting for the extra capital brought in by the SPAC’s sponsors and other friends and family.
An index of 25 companies that went public after merging with a SPAC had underperformed the S&P 500 Index by more than 50% points this year. However, the appeal continues for some investors, has reached new heights of excitement and spectacle just a month ago when former President Donald Trump revealed plans to start a new media company and merge it with a SPAC. The stock of the SPAC increased by almost 1,600% in less than two days, well before Trump’s app was even available for download. SPACs may appear mysterious, but with so many actors, artists, sports, and politicians lining up to pitch them, the blank-check corporations may outnumber the previous craze. Investing in a SPAC merely because a celebrity promotes or invests in it is never a wise idea.
What Impact Do SPACs have on Private Equity?
The growing popularity of special-purpose acquisition corporations (SPAC) is drawing attention to the PE space, where promising portfolio businesses provide significant sponsor incentives and investor returns. SPACs, as ravenous buyers of private companies, are receiving as much attention on New York’s Park Avenue as they do on Wall Street. However, if private equity firms wish to take advantage of SPAC prospects, they may need to assist their portfolio businesses in preparing for the journey ahead.
Surprisingly, just 8% of fund managers polled in November 2020 for Preqin’s 2021 Global Private Equity & Venture Capital Report claimed they had competed for an acquisition with a SPAC, and only 1% said they had lost out. SPACs have had little influence on the majority of private equity GPs’ businesses (64%). However, this may change, since 26% of respondents considered them as a possible departure option, with 5% of GPs having successfully exited via a SPAC.
The later-stage venture capital space has seen some of the most high-profile SPAC deals, giving an alternative to a listing or pre-IPO round. Grab, a Singapore-based taxi service has merged with a SPAC financed by Altimeter Capital to go public on Nasdaq. Altimeter’s vehicle has committed $750 million of a $4.5 billion PIPE funding round, valuing Grab at around $40 billion. Altimeter is based in Boston and Menlo Park with $10bn in AUM across early- and later-stage venture capital and hedge funds.
The high volume of SPAC activity is putting pressure on the deal market. PE firms should be wary of allowing themselves, and particularly their portfolio companies, to be forced into a process with limited tolerance for error or mistake due to a lack of funds. Consider that SPACs are increasingly focusing their efforts on overseas targets, where completing a de-SPAC deal is considerably more difficult. Because SPAC candidate companies may also be PE portfolio targets, PE firms may want to consider how SPACs might help them monetize their portfolio and become more competitive. SPACs may be a better option for the kinds of firms that receive PE financing and support.
Future Outlook
Long-standing worries about public shell corporations have been reignited by new regulatory scrutiny and high-profile blow-ups. Many backers, on the other hand, appear unfazed. This is largely due to the emergence of notable financial figures such as hedge fund manager Bill Ackman, investment banker Michael Klein, and former Credit Suisse CEO Tidjane Thiam as SPAC entrepreneurs. SPACs have become so popular that celebrities like Jennifer Lopez and Shaquille O’Neal have promoted them outside of Wall Street.
Given the evident economic advantage to those sponsors, PitchBook thinks that SPAC sponsors still have a motivation to raise new SPACs while the market is receptive and hungry for expansion. Although getting transactions done may be more difficult for sponsors, the SPAC market will continue to be an appealing channel for bringing private firms public. Institutional investors will benefit from the capacity to provide PIPE financing, which provides more transparency throughout the transaction, as well as access to sponsors and target management teams. Although the number of new special purpose acquisition company agreements has slowed this year, we believe SPACs are here to stay.
Will the SPAC boom stay?
Transforming private businesses into publicly traded companies entails a certain level of risk as the products of the SPAC boom largely haven’t yielded greater returns for investors. However, opponents claim that the problem is that SPAC objectives are frequently not ready. It’s also impossible to sift out the duds without the comprehensive regulatory filings and due diligence necessary in traditional IPOs. The SPAC boom has also yet to pick up in popularity beyond the US, with 79% of SPAC acquisition targets being concentrated in the US. Over the last eleven months, market dynamics have shifted, and sponsor teams have significantly improved. As a result, fewer investors are withdrawing their funds. That’s what we discovered after looking at redemption data since the research finished. Ultimately, the SPAC merge is likely here to stay.
This article has been co-authored by Vivek Kumar, who is in the Research and Insights team of Torre Capital.
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