SPAC's, the Rage of Today
What do Virgin Galactic, Nikola, DraftKings, Fisker and QuantumScape all have in common? They all went public by merging with a Special Purpose Acquisition Company, or SPAC. Even though SPACs have been around a long time, they only really gained momentum in 2020 as market turbulence related to the pandemic made IPOs more difficult. In the two+ months of 2021, SPACs have gained even more momentum, moving out of the realm of proven investors as sponsors and into the likes of actors/actresses, professional sports stars and musicians. All of this activity has even spurred the SEC into action, releasing a statement on March 10th (here) warning investors about the appropriateness of SPACs regardless of the celebrity or celebrities involved. There is a lot of information available about SPACs, and this article will just scratch the surface. The objective is to provide you with enough working knowledge of SPACs so – should these type of companies interest you – you will have the resources to dig even deeper. At the time I am writing this, there are 341 SPACs to choose from, and there are also three ETFs with very different strategies. If you want to learn more about SPACs through audio podcasts, I have included a link at the end of this article for one from Money Talks in The Economist that might interest you.
What exactly are SPACs, and why are they so popular now? SPAC’s, also referred to as blank check companies, are shell companies created by a sponsor which are taken public via an IPO, and then are used to acquire what is usually a late-stage venture capital-funded private company (the “target”). Going public through a reverse merger into a SPAC allows the target company to bypass the traditional IPO route. An IPO for a SPAC at inception is relatively straight-forward in that the company has no operating history, no assets aside from cash that is raised in the IPO, and no real business to speak of. As a result, the disclosure for a SPAC IPO is very light compared to what would normally be required for a company with operations and a real business. The most important considerations for investors are the sector / industry that the SPAC intends to target, the qualifications of the sponsor and management team as far as the sector / industry, and the mechanics of the SPAC as far as the rights of shareholders when a target is identified.
The mechanics of a SPAC. SPACs are normally listed at $10/share, because they have no intrinsic value aside from the capital raised in the IPO. Often shares are sold in conjunction with warrants which typically have an exercise price that is a premium to the stock price at issue, and together, the shares and warrants are sold as units. Following the IPO of the SPAC, the stock and warrants often trade separately, which allows IPO investors to sell their shares and retain the warrants, or vice-versa, should they not wish to continue to hold both. Money raised through the IPO is held in a segregated trust until an acquisition occurs or the SPAC is wound down. Although the window to make an acquisition can vary, most SPACs have an 18 to 24 month time limit in order to consummate an acquisition. If an acquisition is not identified within this window, the SPAC is wound down and proceeds from the IPO are returned 100% (plus interest) to the shareholders. If a target is identified, the shareholders have to approve the acquisition, which normally requires a 50% majority vote in favour although the threshold can be set higher. Investors also have the option to redeem their shares and exit the SPAC at the original IPO price (usually $10/share) if they prefer not to carry on post-merger. As far as size of the investment of SPAC proceeds, it has to be large, usually accounting for at least 80% of the SPAC’S trust assets. Generally, 15%-49% of a target company is acquired by the SPAC, such that the new shareholders in the public company post-merger are a mix of the original SPAC investors, the existing investors in the target, and the sponsors (through promote – more on this below). Occasionally, additional capital will be raised at the time of the transaction in the form of a PIPE, or “private investment in public equity”, which can provide some additional investment to fund the transaction (e.g., in cases where the target is too large for the SPAC to consummate the transaction on its own).
Where do SPACs most often appear? SPACs have largely been a US phenomenon to date, with very few SPACs popping up in Asia or Europe as you can see in the table below from Refinitiv (via Forbes).
Just recently we are starting to see the announcement of more European SPACs. In fact, one interesting sideshow occurring at the moment is a rather fierce battle between continental European financial centres and London over attracting SPACs. After a few European SPACs announced that they would go public in Amsterdam, the London Stock Exchange responded by announcing that it would be relaxing its rules for blank check companies, making the LSE much more appealing for SPACs. Clearly, European financial centres are expecting more SPAC IPO’s, and they are fighting to have their exchanges host these issues rather than London or New York.
How do the economics of SPACs work from the perspective of SPAC sponsors, investors, and bankers? Let’s talk about the sponsors first. Although occasionally sponsors will invest real money in a SPAC, most of their compensation is derived from founders shares that they acquire at a nominal price (say $25,000) at the IPO. These shares vest upon the consummation of a transaction. Founders shares typically represent 20% of the company post-acquisition, providing compensation for the sponsor (including for the management team) for the period prior to the consummation of a successful acquisition. The founders shares – or promote – is to compensate the sponsor team and management who are not usually paid prior to an acquisition closing. In other words, it is to provide remuneration for the sponsor during this barren period when there is considerable time and effort spent to identify a suitable acquisition target. It goes without saying that when a SPAC consummates a successful acquisition, this can be extremely lucrative for the SPAC sponsors. In fact, one of the largest complaints that critics level at SPACs is that the promote tends to cause the objectives of the IPO investors (maximise returns on the shares they have purchased) to diverge from the sponsors (close an acquisition within the timeframe allotted, even if it is not the best one, because this triggers the vesting). At the end, it is usually the SPAC (public) investors that are diluted more heavily by shareholders of the target (and PIPE investors if involved) at the time of the merger, rather than the sponsor.
From the perspective of investors, buying into the IPO of a SPAC is speculative but offers an opportunity to get in on the ground floor of what might be a fast-growing last-stage venture capital-sponsored company. Although admittedly a blind pool approach, SPAC IPOs offer retail investors a much better chance of participating in a lucrative IPO than would an IPO of a “hot” operating company in which shares are typically allocated to the largest institutional accounts (instead of retail investors). In addition, there is embedded optionality in that investors participating in the IPO can choose to stay invested once a target is identified or can instead decide to take their money back at the IPO price, exiting the SPAC. (Note that secondary investors in a SPAC that is trading above the IPO price are only entitled to redeem their shares at the IPO price, not at the price at which they purchased the shares, if this is higher.) Investors also receive considerably less information on the target company than they would in a traditional IPO, setting the stage in several cases for alleged fraud, a topic I will touch on in more detail below.
From the perspective of investment banks, SPACs can be lucrative transactions because investment banks get paid a fee for the IPO of the SPAC (have seen a range mentioned of 2% to 7%), and they will also earn a commission on the M&A transaction should an appropriate target be identified and the acquisition consummated. Of course, there could be other fees for things like financing, hedging, and so forth. SPAC transactions might not be as visible or prestigious as large IPOs, but they appear to me to be just a remunerative, if not more so.
What makes SPACs attractive to target companies that wish to go public via a reverse merger instead the traditional IPO route? For targets, merging into a SPAC as opposed to an IPO (or a direct listing) provides much more certainty. IPOs can take months to prepare and are expensive for a company. Just when a company wishes to pull the trigger and start the marketing of the IPO via an investor roadshow, market sentiment can change so quickly that the IPO window could close. An unreceptive market can continue for an extended period of time, meaning a company in need of financing cannot move forward in its evolution. The disclosure for a traditional IPO is also very extensive and expensive, often overwhelming companies that have, until then, been private and not subject to the extensive requirements of the SEC and the listing exchange. By forgoing a traditional IPO route and instead merging into a SPAC, target companies greatly reduce the uncertainty around execution risk. They also forgo the extensive disclosure, and the legal and due diligence costs, that are otherwise required for an IPO or direct listing. The negatives of a SPAC merger for a target company are that the transaction does not usually generate proceeds for the target (as money goes to the target’s shareholders), and the transaction might not be as visible as a highly successful IPO.
How successful have SPACs been in consummating acquisitions? The best data I could find on the success of SPACs as far as successfully acquiring target companies was on the website spacinsider.com. According to some of this data, roughly 30% of SPACs created since 2009 have announced or completed acquisitions. In the most recent year (2020), 106 SPACs announced or completed acquisitions and no SPACs were liquidated. 251 SPACs are still on the prowl for targets as of the most recent data, and another 211 SPACs are set to do IPOs. The more crowded the arena gets with SPACs, the better it is for sellers of target companies and the worse it is for SPAC investors. From the perspective of sponsors, I view this as a no brainer in that aside from some modest costs, the risks and investment for sponsors are limited, and the returns are highly – some would say unfairly – skewed to the upside.
How many SPACs are there? According to the website Stock Market MBA, there were 341 SPACs as of March 15th 2021. In 2020 in the US, 237 SPACs were listed comprising $79.9 billion, a significant increase over 2019 when there were 59 SPAC IPO’s (source: Nasdaq.com). SPACs represented more than 50% of all IPOs in 2020. Although 2020 was a huge year for SPACs, 2021 is off to an even faster start. According to SIFMA, $60.2 billion of new SPAC IPOs have occurred YtD globally through the end of February (more than 70% of the total for all of 2020!), illustrating the dramatic increase in SPACs as a broader array of sponsors jump into this market. Probably the best data base for SPACs is surprisingly free and available on the website spactrack.net, which you can find here.
Although the US has dominated SPAC issuance, the fad is clearly heading east fast, as I mentioned earlier. In January, LVMH founder Bernard Arnault and former UniCredit chief Jean Pierre Mustier announced that they are creating a FinTech-focused SPAC (Pegasus Europe), and other prominent European sponsors that have or are considering SPACs include the likes of Xavier Niel (two, TV production and organic food), Tidjane Thiam (FinTech but apparently US listed), former UBS chief Sergio Ermotti, ex-Commerzbank boss Martin Blessing and Barclays investment banker Makram Azar.
Are there ETFs for SPACs? Yes, there are three SPAC ETFs each with different strategies.
1. Defiance Next Gen SPAC Derived ETF (SPAK), which is a passive, market-weighted index investing in both pre- and post-acquisition SPACs. The weighting is 40% pre-acquisition and 60% post-acquisition. The ETF has $78 million of AuM and an expense ratio of 0.45%.
2. SPAC and New Issue ETF (SPCX), which is an actively managed ETF investing only in pre-acquisition SPACs. The ETF is managed by Tuttle Tactical Management. This fund has $153 million AuM and an expense ratio of 0.95%.
3. Morgan Creek – Exos SPAC Originated ETF (SPXZ), which is also an actively managed fund, but unlike SPCX, invests in both pre-acquisition and post-acquisition SPACs. The fund is about one-third pre-acquisition and two-thirds post-acquisition SPACs, with the holdings equally weighted (rather than market-cap weighted). The sponsor is willing to hold post-acquisition companies for long periods of time. This ETF has $32 million of AuM and has an expense ratio of 1.0%.
Both SPCX and SPXZ are relatively new SPAC ETFs. The graph below shows the performance of all three SPAC ETFs over the last three months. This compares to the return on the S&P 500 and Nasdaq Composite of 16.6%% and 17.6%, respectively, over the same period.
Who are some of the key players in the SPAC world? Some of the better known investors and company (operating) executives who have “earned their stripes” well before they sponsored a SPAC included the likes of Bill Ackman (Pershing Square Capital), Ian Osbourne (Hedosophia), Jeff Sagansky (producer and production manager), Chamath Palihapitiya (former Facebook executive and CEO of Social Capital), Harry Sloane (media investor, entrepreneur and studio executive), Michael Klein (former Citibank executive and founder/CEO of Churchill Capital), Dan Loeb (activist investor, founder of Third Point), and Howard Lutnick (Chairman & CEO of Cantor Fitzgerald).
The rapidly growing popularity of SPACs have also drawn in plenty of celebrities with limited (or perhaps no) background in financial markets. Some of the names that have entered the SPAC world as sponsors or board members/advisors of SPACs include the likes of Jay-Z, Shaquille O’Neal, Serena Williams, Alex Rodriquez, Colin Kaepernick, Steph Curry, and former politician Paul Ryan. These names provide gloss and cache value to a SPAC, although it is hard to see any merit from an investment perspective given the heavyweights that are sponsoring many other SPACs. They might however provide a competitive edge for a SPAC that is seeking a target in which the sale of the company is competitive, and the selling shareholders and target might like the involvement of a celebrity for one reason or another. As I mentioned in the opening of this paper, the SEC just put out a paper warning investors against celebrity-“endorsed” SPACs, which is here.
Four of the most visible and successful SPACs that have consummated acquisitions to date include:
DraftKings (sports betting), Diamond Eagle Acquisitions, Jeff Sagansky/Harry Sloane
Virgin Galactic (commercial space travel) and OpenDoor (instant home offer), two different Hedosophia SPACs, Chamath Palihapitiya
Clarivate (date and analytics), Churchill Capital II, Michael Klein
Are some SPACs less successful than others? Some SPACs are not successful, and failure can happen two ways. Firstly, the SPAC can simply fail to consummate an acquisition within the specified time frame, normally 24 months. In this case, initial IPO investors get their money back with interest, but have suffered an opportunity cost in that the money could have invested in higher return assets elsewhere during this period. Although a failure, the cost to investors is not severe. Secondly, a SPAC can fail if an acquisition is completed, but it does not live up to the expectations of shareholders, causing the price of the SPAC shares to fall when an acquisition is announced, or perhaps later after the transaction is consummated. There can be extreme volatility when a transaction is announced but before it closes, especially if the SPAC shares have been bid up too quickly before the announcement and – for one reason or another – the target is deemed to be less attractive than hoped. In this case, the shareholders of the SPAC hold a put at the IPO price, so if they believe that the poor performance of the shares is sending a negative message, they can take their cash and exit the transaction. Once a transaction closes, the worst case scenario for the original SPAC investors that opt in is that the target underperforms and the price of the shares falls below the IPO price (or even to $0 if the company fails).
The most common difficulty so far with SPACs seems to be fraud, perhaps related to the more limited disclosure required when a target is acquired. Some of the better-known cases of alleged fraud (some proven) involving SPACs have included:
Modern Media Acquisition Corp (SPAC), target Akazoo ($200m)
InfoGenie (SPAC), target WireCard (albiet old, 2005)
Spartan Energy Acquisition (SPAC), EV company Fisker (value implied $2.9 bln)
VectolQ Acquisition Corp (SPAC), electric truck maker Nikola (value implied $3.3 bln)
Churchill Capital (one of its SPACs), target healthcare services company Multi-Plan (value implied $11 bln).
In all of these cases, fraud is suspected and investors that speialise in short selling have gotten involved in the shares to promote and eventually expose the fraud (should it exist). Some of these post-acquisition SPACs are down 70-80% off their highs
How have SPACs performed? The performance of SPACs has been mixed. I came across a couple of SPAX indices, but their histories are short and they don’t seem particularly mainstream just yet. The first – the INDXX SPAC & NEXTGEN IPO INDEX (ISPAC) – is a passive index with 174 constituents, with data starting on April 30th 2020. You can find the information on this index here. A second index is the IPOX SPAC index, which is a market-weighted index of the 30 largest SPACs. The IPOX SPAC factsheet is here. The graph below illustrates the returns of this index.
If you know of others, please let me know. Given the diversity of SPACs and difference in their stage of development, indices would seem difficult not only to design but to be meaningful.
CNBC also has a SPAC index (50 SPACs, not sure how chosen or weighted), and the returns since inception of the index in November 2020 are illustrated in the graph below.
As you can see, SPACs have not performed well since mid-February, well off their highs. This graph below from spacinsider.com gives the same message although over a slightly longer period. Interestingly, it shows the much more extreme volatility of larger SPACs (red line) than all SPACs equal weighted (yellow line). However, the market cap weighted index, biased by larger albeit more volatile SPACs, has outperformed the S&P 500 over the same period, whilst the equal weighted SPAC index has outperformed the S&P 500.
Podcast recommendation. If you prefer podcasts about SPACs, here’s a nice primer and recent, although you will find plenty out there regarding SPACs: “The SPECtacular boom changing global finance”, from The Economist radio (“Money Talks”), dated March 9th, 2021.
If you want to invest in a SPAC or SPACs, do your work on the sponsor (or ETF), because now you should have the mechanics of understanding how these interesting investment vehicles work. Post-acquisition, the SPAC really is just like any other company, so the value is in getting in early and hoping for the best in terms of an attractive merger target.
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