WATCH: What are SPACs?
SPACs may sound strange but they are one of the hottest trends in global investment at the moment.
Over $100bn (£72bn) has been poured into SPACs over the last year and the UK is hoping SPACs will be a growth area for its stock market post-Brexit. The market is also "a major area of growth" for European investment banks, according to Barclays Capital.
Not everyone is so excited. There are concerns that the SPAC boom could turn into a bust and hurt small-time investors. That shift may already be underway.
Whatever happens, SPACs are likely to remain in the headlines for years to come. The sums already raised mean a steady stream of SPAC deals are likely to be announced.
Here's everything you need to know about SPACs and why everyone's talking about them.
What is a SPAC?
SPAC stands for Special Purpose Acquisition Company. They are also known as “blank cheque companies.”
SPACs are essentially empty cash shells — companies with no operations that are created simply to hold investor money and then spend it. Management try to identify a company or assets to buy, thus giving the SPAC stake inherent value.
SPACs typically target deals to take private companies public. The benefit for companies that get acquired is it can be a quicker and easier way of listing on the stock market.
Notable examples of companies that have gone public through SPACs include Nikola (NKLA), DraftKings (DKNG), and Virgin Galactic (SPCE). Social Capital founder Chamath Palihapitiya is the best known SPAC "sponsor," as founders of the vehicles are known.
How do they work?
SPACs raise money through an initial public offering, meaning they sell shares that are then traded on a public stock exchange. Convention dictates that shares are priced at $10 a piece but there is no rule saying they must be sold at this level.
SPACs are structured so that investor funds are held in Treasury while management seek to identify a deal, meaning investor funds can't be spent. SPAC sponsors take a fee once a deal closes, usually in the form of a 20% stake in the company being acquired. There are underwriting fees associated with the IPO but these are usually passed on to the target company.
Once a deal is identified, shareholders are asked to vote to approve a takeover via a simple majority.
SPACs usually look for deals that are several times larger than the cash shell. Additional financing is arranged through what's known as a PIPE deal — private investment in public equity. Funding is usually supplied by private equity funds.
Why is everyone talking about SPACs?
SPACs have been around for decades but they exploded in popularity last year. SPACs raised around $80bn in 2020, accounting for half of all the money raised through US IPOs.
The boom came in part due to a surge of retail interest in the stock market. Financiers sought to tap this trend by connecting investors to opportunities in private markets via SPACs. Low interest rates and a glut of private companies helped.
The boom has continued into 2021. 90 SPACs raised $32 billion through IPOs in February, according to Goldman Sachs, making it the largest issuance month on record.
The hot market has attracted figures not normally associated with high finance. Sports stars including basket baller Steph Curry, tennis champion Serena Williams, and skateboarder Tony Hawk are all involved in SPACs. Connections like these have only heightened attention on the market.
Britain is hoping to tap into the boom. The UK's government recently proposed stock market reforms to make it easy for SPACs to list in London.
What’s in it for investors?
Investors who back SPACs are essentially betting the team behind it can identify good deals.
Companies have been staying private for longer and longer. As a result, much of the growth — and investor return — happens before public market investors get a chance to buy in. When businesses do finally go public, retail investors are often shut out of the IPO process. IPOs often "pop" on their first day of trading, leaving investors buying right at the very top.
SPACs let retail investors get a slice of the action earlier. Through the deal structure, SPAC shares will convert into a holding in the target company. Your $10 stake in a SPAC today might turn into a share of a hot, innovative company tomorrow that’s worth $20 shortly after the deal completes.
Investors will pick a SPAC based on the industry that it is targeting or the track record of the people running it.
Ultimately, SPACs are a bit like the mystery box on a gameshow — the hope is that when you open it, you find something beyond your wildest dreams. Investors get to vote on whether to approve a SPAC takeover, meaning duds theoretically can't be forced through.
Investors also get downside protection. Under the SPAC structure, investor cash is returned in full if a deal can't be done within two years. That's not a bad pitch in an era of ultra low interest rates.
What are the risks?
The problem with the mystery box option is you could end up with something much worse than what was on offer elsewhere.
Charlie Munger, Warren Buffett's right hand man, recently called SPACs "an irritating bubble" and said it was a "kind of crazy speculation in enterprises not even found or picked out yet".
"I don't participate at all," the 97-year-old billionaire investor said. "And I think the world would be better off without them."
Goldman Sachs estimates that over $100bn of SPAC money targeting deals at the moment. Through additional financing, it could lead to $700bn of takeover activity in the next two years.
Finding $700bn-worth of private companies that are ready and willing to go public via SPACs — and will deliver investor upside once they do — could prove challenging. That amount of money chasing a limited number of deals could also lead to inflated prices.
David Schwimmer, the chief executive of the London Stock Exchange, said this month there was “clearly some froth” in the market and warned it “could end poorly” for many investors.
The SPAC market follows “boom and bust cycles,” according to a recent JP Morgan note. One sign of a bust is “the emergence of poor quality players.”
After reaching a high last month, an index that tracks SPACs entered a “bear market” at the start of March — defined as a 20% fall from the peak of prices. Shares in many SPACs are now trading below the value of the cash they hold, a sign that the market is not optimistic about the prospects of delivering value for investors. JP Morgan said there were “signs of peaking in SPAC prices and activity.”
Beyond concerns about the sustainability, there are also more mechanical issues that could pose problems.
PIPE deals can dilute SPAC investors, leaving them with smaller stakes in the target company than they might have imagined.
SPACs themselves are also beginning to complain about investor engagement. The Financial Times reported that SPAC deals are increasingly being derailed because investors are failing to show up to votes on the deals.
It remains to be seen what SPAC deals will mean for governance. Going public via a SPAC involves less scrutiny from investors upfront. Avoiding time consuming investor roadshows is a plus for many management teams, but it could mean issues get missed. The founder of Nikola, one of the highest-profile SPACs, was forced to step down last year after the electric car company was accused of exaggerating claims about its achievements and abilities. Earlier and broader scrutiny may have spotted issues like this.
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