Empty shells sell well

Special purpose acquisition companies (SPACs) are currently in vogue on Wall Street. These blank-check funds enable companies to go public quickly without the hassle or restrictions of a traditional IPO, and they are usually a lucrative business for their founders. Investors, on the other hand, buy a pig in a poke and sometimes get left holding nothing.

 

Four letters: SPAC

The year 2020 was a nerve-wracking one for many people, including players in the area of corporate mergers and acquisitions (M&A). In the beginning, the pandemic made the notion of corporate takeovers seem like a vision from long lost times for a few months. But then an unprecedented spree of M&A activity burst into motion even though the public health crisis continued to rage ceaselessly. Amid the twists and turns of 2020, the single biggest thing on M&A advisors’ minds in the age of the coronavirus can be summed up in four letters: SPAC. This acronym stands for “special purpose acquisition company.” SPACs were the undisputed stars of the M&A industry in 2020. Once dismissed as a shady Wall Street relic, SPACs have since become one of the hottest trends in the finance industry. The numbers speak for themselves: 248 SPACs were founded last year, according to SPAC Insider, marking a fourfold increase compared to the prior year. The average size of a SPAC amounted to USD 335 million, almost ten times larger than in 2009.

 

Bestsellers

SPACs are selling like hotcakes

Number and size of SPAC IPOs in the USA

Sources: SPAC Insider, Kaiser Partner Privatbank

 

But what exactly are SPACs, and what makes them so attractive? Basically, SPACs are publicly traded corporate shells that are founded for the sole purpose of merging with a privately held company to give the takeover target a ready-made stock-exchange listing. Those who invest money in a SPAC shell usually do not know at the time of their investment what company their money will ultimately flow to – they literally buy a proverbial pig in a poke, which is why SPACs are sometimes also called blank-check funds. The appeal of SPACs, however, is manifestly evident for the founders of these takeover vehicles, who are also called sponsors, and for the sellers of privately held companies: sponsors generally receive a 20% equity stake at very little cost, called the “promote,” which turns into a big stake in the target company after a merger. The sellers, in turn, can directly go public quickly without the hassle or restrictions that the significantly longer (and more circuitous) traditional IPO route entails, a benefit that attracts venture capitalists in particular.

The dazzling list of SPAC sponsors has grown longer and longer in recent years, ranging from former baseball general manager Billy Beane to legendary entrepreneur Richard Branson and Paul Ryan, the former speaker of the US House of Representatives. Hedge fund mogul Bill Ackman even raised a record USD 4 billion in July, enough to let him reportedly approach Airbnb about a merger. That merger gambit ultimately didn’t bear fruit, but the mere idea that a SPAC could swallow an acquisition target of that size speaks volumes. Shrewd bankers, meanwhile, are on the search for financial setups that would enable even more money to be funneled into SPACs in the future so that they can acquire ever larger target companies. M&A industry spokesmen expect the SPAC craze, which has mainly been an American phenomenon thus far, to spread worldwide. In December, French billionaire Xavier Niel raised EUR 300 million for a blank-check fund, notching the biggest market debut in France last year.

 

Persistent weak returns could curb investor appetite for SPACs in 2021.

What could possibly go wrong?

As the new year gets under way, the question arises as to whether the SPAC world will stay as rosy as it has been of late. Warning signs pointing out the potential risks for investors have already been flashing in recent months. For instance, some of the acquisition target companies in SPAC deals, such as electric-truck maker Nikola Corp., have stumbled badly since going public. Even if there haven’t been any scandals, many blank-check companies have underperformed the S&P 500 index since going public. Persistent weak returns could curb investor appetite for SPACs in 2021. Moreover, SPACs could end up becoming a victim of their own popularity. More than 200 blank-check funds sitting on a combined total of USD 70 billion are searching for takeover targets. This implies potential purchasing power of approximately USD 350 billion since additional capital from outside investors typically enables a SPAC to merge with a company five times larger than itself. SPACs usually have only two years’ time to find a takeover target. If they fail to find one during that period, they are contractually obligated to return the money to investors. This puts them under time pressure, which could lead to them crowding each other out of deals or could result in mergers born of urgency instead of prudence.

Last but not least, one of the main reasons for the soaring popularity of SPACs – the disappointing performance of “normal” IPOs – may fade going forward. The enormous run-up in the valuations of companies like Airbnb and DoorDash in their recent IPOs may prompt some companies to return to more traditional ways of going public, leaving SPACs with billions of dollars but fewer targets worth buying.

 

Oliver Hackel, CFA Macro and Investment Strategy, Behavioral Finance and Technical Analysis

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