SPACs: A Changing Landscape for Investors

SPACs: A Changing Landscape for Investors

For decades, special purpose acquisition corporations (SPACs) have been utilized to list companies. SPACs, also known as blank check corporations, were not nearly as popular or prevalent as the standard initial public offering (IPO) procedure until 2020 – SPACs have gained popularity in recent years because of the pandemic, which resulted in an infusion of new traders and retail investors, as well as the exposure of numerous speculative parts of the market.

Although the exploding SPAC issuance cycle has already peaked, investors continue to have various concerns about them, including their past performance and prospective hazards. These are very complicated vehicles that vary considerably in terms of size, construction, and quality.

A More Direct Route to Public Marketplaces

SPACs are often a less onerous route for businesses seeking to go public. They are founded by a sponsor (either a private equity firm or a former corporate leader), who collaborates with an underwriter to bring the business to market as a blank slate. The funds are acquired via a public stock offering, and the SPAC is listed on an exchange with the objective of acquiring a target firm. When (and if) a merger occurs, the SPAC assumes the target company's identity and symbol.

One of the primary benefits for target firms is the chance to discuss the future and make forecasts, which are typically restricted during the typical IPO process. This is an especially compelling proposal for SPACs in search of innovators and disruptors. Additionally, no roadshow is necessary, as the sponsors of SPACs have already secured funds in a single vehicle. This streamlines the procedure and saves both parties considerable time.

For the ordinary investor, SPACs provide a direct route to emerging firms, formerly reserved for giant institutions and hedge funds. Additionally, they provide an appealing affordability characteristic. Typically, investors may acquire a blank business unit for $10, which includes one share of common stock and a portion of a warrant, which gives the right to purchase more shares at a specified price in the future.

Fee structures vary, but typically involve a 20% equity investment by the sponsor. After bank fees, the cost to public investors at the time of the SPAC's initial public offering, and/or the cost of the merger with a target company, the costs associated with SPACs are frequently significantly higher than those associated with traditional initial public offerings.

A Fading Performance

Along with risk, investors are focused on the performance of SPACs. As previously stated, issuance has already seen a boom-and-bust cycle. SPACs gained popularity in 2020, and their proportion of overall IPO activity grew as a result of the wave of issuances (both in terms of total transaction value and number of firms), as seen in the figure below. By February 2021 – the pinnacle of activity – the value of SPACs had surpassed half of the entire value of US initial public offerings.

Figure 1: SPACs as a %age of IPOs in the United States (as of 31/01/2022). Source: Bloomberg

Performance has been substantially consistent with issuance activity. Numerous factors contributed to the second half of 2020's growth of several speculative pockets of the market, including an abundance of liquidity (thanks to fiscal and monetary support) in the aftermath of the pandemic, increased interest in day trading, and the incredibly rapid recovery of stocks from the S&P 500's March 23, 2020 low.

Figure 2: Collapsing performance of SPAC indexes (as of 31/01/2022). Source: Bloomberg

In February 2021, SPACs across all sectors – as assessed by the ISPAC Index – quadrupled in value since mid-2020. Those who had previously identified a target to combine with—as indicated by the De-SPAC Index—saw a 60% reduction in relative gains. Since seen in the accompanying figure, the pinnacle of the frenzy looks to have passed us by, as the ISPAC Index's gains have totally vanished. The De-SPAC Index's performance is even worse, since its value has decreased by more than half since its high in 2021.

Speculative SPACs No More

While the period of speculative excitement for SPACs looks to have passed, many remain active in their quest for target firms. Given the plethora of SPACs on the market and the continued high demand for targets, the crucial metric to monitor will be the sustainability and length of merger activity. The precipitous decline in overall performance since the start of 2021 indicates that investors are no longer ready to pay larger premiums, and the disappointing performance of SPACs that announced transactions this year indicates that deal euphoria has subsided.

Nonetheless, this year is likely to be quite eventful since many companies are still searching for acquisition targets.Many have already stepped forward, as the SPAC buyout rate – a measure of shareholders wanting their money back rather than backing mergers – will approach 60% by the end of 2021. As with any investment, the risks connected with these SPACs must be thoroughly assessed.

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