Special Purpose Acquisition Companies or SPACs for short have been a much-used financial instrument over the last years and were specifically hyped during the pandemic years.
SPACS are not new, but appeared to be the shiny new toy every serious big player in the financial markets wanted to get involved in. Listing a SPAC is like a badge of honour and a way of saying you have found a seat inside a cash machine.
What do SPACs do?
SPACs are shell companies, meaning they have no business activity at the time of listing. They are ‘blank cheque’ companies as the funds raised via the listing – often with well-known underwriters to back the SPAC – is mostly used to buy privately owned companies, effectively giving that private company an accelerated access to the public market. At the time of the listing of the SPAC the target company may have been identified or not yet. However, the SPAC needs to use the funds to acquire an asset withing 2 years. If it does not do so, the funds will have to be returned to the investors with market interest – read near zero.
Why did SPACs become so popular again in recent years?
With a red-hot stock market and shares of newly listed companies flying of the shelf, many founders of smaller companies wanted to get access to the public markets quickly and raise funds to further grow their businesses. But going ‘public’ via an Initial Public Offering (IPO) takes time and is subject to some intense scrutiny by the Financial Authorities. A SPAC offers a way out by doing things the other way around: list an empty company and reverse merge the target company into it, so the empty company then becomes the new home of the target company and is named after it and ta-daa, the privately owned company is then publicly listed. In 2021 around $87.9 billion was raised via SPACs, a huge increase compared to the $13.6 billion in 2019.
SPACs are big money spinners, for some at least
SPACS can make life easy and allow for fast riches. Instead of listing the business, in effect it is the shareholders who are listed via the SPAC. The shareholders commit the money and in return get promised a portion of the shares of the target ‘acquisition’ company, often at a deep discount. A win-win? It seemed so, for as long as the general market bought any tech stock or any other ‘cool’ company and drove up prices and valuations, SPACs worked fabulously well for all those involved: the target company (1) got fast access to the market; SPAC investors (2) were able to make a ton of money by selling their pre-allotted, discounted shares at market price once the target company was acquired by the SPAC; and lastly, the investment banks (3) made an absolute killing in fees by rolling SPACs off the conveyor belt like hot buns.
But what about outside investors?
Most SPACs, actually 70% of them, did however not create great returns for investors who invested in the target company once it was bought and merged into the SPAC. In 2021, which saw the S&P500 rise by almost 25%, a great majority of SPACs underperformed the market by a mile, with negative returns ranging from -4% to -68%.
That said, about 30% of SPAC companies at the time (before the great 2022 sell off) became happy investor stories, such as Skillz Inc and BeautyHealth. These SPACs created returns in excess of the general market. In today’s bear market, however, even the originally successful SPAC listings are below their first listing price and investors in even those SPACs will sit on heavy losses.
Are SPACs ok to invest in then?
For the average investor, SPACs are stay-away investments. There is often not enough scrutiny on the financial statements of the acquired company; structures can be complex and opaque and besides, most of the money made is by those designing, listing and funding the SPAC and all the first spoils are for them. If a company is fast growing and financially solid, the follow up investors may make some returns too, but this requires a continuous optimistic investor pool with ready cash to invest. But these investors quickly evaporated once the market started to turn. Buying the S&P500 index and holding it for a long time - although this is of course less exciting - would be a better bet than ‘spaccing’ it. Any day.
References & links:
https://www.investor.gov/introduction-investing/investing-basics/glossary/blank-check-company
https://www.cnbc.com/2021/03/19/spacs-break-2020-record-in-just-3-months.html
https://fortune.com/2021/03/04/brexit-europe-finance-london-amsterdam-spacs-financial-center-eu/
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