Unheard of by many pre-2019, Special Purpose Acquisition Companies (or SPACs for short) recently had a bit of a rollercoaster ride. From an average of 50 new SPAC IPOs in 2018-2019 to 387 just in the first seven months of 2021 (see the table below 1). Is it a disruptive innovation that will change the face of the private equity market forever? (How) does it stack up against traditional IPOs?
SPACs, or colloquially, “blank cheque companies”, are formed to raise capital through the initial public offering to buy existing companies. Usually, SPAC mergers or buys out a company in a Reverse Takeover (RTO). Founders of a SPAC have, typically, up to two years to find and acquire businesses, else, the funds have to be returned to the investors. Although managers of SPACs could have an acquisition in mind, the pre-IPO disclosures are generally vague to give founders certain flexibility. Unlike traditional private equity firms, SPACs are open to general retail investors. These factors, in addition to being faster than the traditional IPOs, meant that many private companies opted to cash out and go public via SPACs (creating a supply-side boom). A few notable examples include Virgin Galactic Holdings Inc (NYSE: SPCE) and Opendoor Technologies Inc (NASDAQ: OPEN). Also, the once-failed IPO, WeWork, announced that they are considering raising funds through a SPAC 2.
Noteworthy, to dispel the narrative of SPACs as a disruptive innovation in the financial world, is that private equity firms are investors in SPACs themselves. In the first half of 2021, private equity firms raised a 40-year record amount of capital 3. Much of the SPACs are underwritten by the large investment banks, with more than a third of 2021's underwriting in the US were completed by Citigroup, Goldman Sachs and Credit Suisse 1. Finally, IPOs have seen the best week since 2004 in 2021 4, and some claim that the availability of SPACs (and RTO) creates competition and reduces the cost of going public.
Yet, there are many critics of SPACs and their recent boom (and bubbly behaviour 5). Notably, the recent article by Ivana Naumovska highlighted the dangers and poor historical performance of reverse mergers 6. Lack of a clear investment mandate creates a moral hazard and could invite bad players into the market. This inevitably will be (and is) flagged by regulators (for example, the recent clarifications by the SEC concerning warrants and SPACs 7). On the other hand, a competition among the exchanges, trying to attract the new wave of dealings by creating SPAC-related leniencies (i.e. the Toronto Stock Exchange had zero SPACs issued before adopting certain exemptions 8), can fuel the bubble and expose investors to unforeseeable risks.
Reflecting on the recent private equity and IPO markets, and the players involved, it is hard to see SPACs as disruptors, but rather as “new” (or another) participants. SPAC provides time-to-market advantages for private companies, while also securing a good demand from investors. With (the recent flight of) Virgin Galactic, we certainly saw some of the highs of SPACs, but unavoidably, we shall see its lows too. It is still a novel instrument, and one has to consider it with caution.
4 "Wall Street banks racked up $650 million in fees and stock gains in the busiest IPO week since 2004" https://www.cnbc.com/2021/07/04/banks-earn-650-million-in-fees-and-stock-gains-from-ipo-flurry.html
7 "Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”)" https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs
N.B. This article does not constitute any professional investment advice or recommendations to buy, sell, or hold any investments or investment products of any kind, and should be treated as more of an illustrative piece for educational purposes.
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