Are SPACs sustainable?
SPACs are gaining a lot of popularity in recent years. Before we arrive at a conclusion on whether SPACs are sustainable or not, let’s build some understanding of SPAC and its history.
Introduction
SPAC
SPAC (Special Purpose Acquisition Company), also known as blank-check (Investopedia, 2020), are public shell companies that exist for a single purpose to find and acquire a private company and take it to market quickly. The company would get a spot on the exchange with its ticker. SPAC transforms into the target company taking on its name. Once the deal closes, investors who own shares in the blank check company now owns the piece of share in the new entity.
The below diagram explains the process flow in a picture.
SPAC companies are owned by veteran corporate leaders and big investors like private equity firms.
Trends
SPACs have been around for decades, roughly from the 1980s, but it is becoming more popular recently. As shown in the below chart, we can see that SPACs have grown 20 times since 2012 and have tripled since last year.
SPACs have become an attractive offer amid COVID-19 when it has become challenging for the companies to go public in the year 2020, SPAC contributed to 44% of the total IPOs.
Recent examples include: (Market Watch, 2020)
1. Sports-betting operator DraftKings Inc. merged with SPAC Diamond Eagle Acquisition Corp. and a gambling tech business, SBTech Global Ltd., earlier this year. The renamed DraftKings has been on a tear, gaining 258% in the year to date
2. Electric truck maker Nikola Corp. merged with VectolQ Acquisition in June and immediately benefited from the cult status enjoyed by fellow electric vehicle maker Tesla Inc., which has propelled that stock to record levels this year. Nikola has gained 232% in the year to date.
3. Space travel company Virgin Galactic Holdings Inc. merged with Social Capital Hedosophia last October. The stock is up 35% in 2020,
Benefits of SPAC
Target Companies
1. The target companies can go public without much of the volatility associated with a traditional IPO
2. Target companies go public faster than traditional IPOs
3. In the SPAC merger, the management team will often retain at least one key person for an active role within the company or on the board as a key consultant. This mitigates the risk of the company failing to meet investor objectives after any key deal is consummated.
4. SPAC is a good alternative for companies that may not make a cut for Traditional IPO but still have large potential growth prospects.
Investors
1. Investors get access to high-reward investments with limited risk
2. A larger number of investors can participate in the SPAC pool, like crowdfunding
3. Investors get 20% shares of the company for acquiring the target company
Comparison (IPO vs. Direct Listings vs. SPAC)
Personal Perspective about SPAC relative to Traditional IPO
THE more I read about SPACs more I feel suspicious about it. It remains a point of concern that companies going public through SPACs are not getting as much scrutiny as those using traditional IPOs. It can or is opening a bridge for companies to commit frauds, and there are no regulations to monitor or control the companies creating deceptions.
A recent example is Nikola, which went public through a SPAC a few months ago and has turned out to be the center of a firestorm of fraud allegations. Nikola shares are tumbling after a short-seller called the company quote, “An intricate fraud built on dozens of lies.”
An article from Hindenburg Research (Hindenburg Research, 2020) writes in detail about Nikola’s frauds, which could have been averted if it had gone through a traditional IPO. There would have been more time for investors to kick the tires and scrutinize the company for fraud before it went public, like the same way investment banker caught the WeWork fraud before going public.
Federal regulators are raising concerns as well. The SEC is now examining how blank-check companies disclose their ownership and how compensation is tied to an acquisition.
They want to make sure that investors understand those things. At the time of the transaction, when they vote, they are getting the same rigorous disclosure that you get in connection with bringing an IPO to market.
SPACs have often been a lousy deal for companies going public. When they do a deal, the founders of the SPAC get to have a 20% stake in the company that results from the deal without having to pay very much for it. And so essentially a way they can line their own pockets. The future of blank-check companies remains unclear. Investors say SPAC deals are here to stay, while critics argue that the blank-check boom is just a trend that is not destined to last.
When are SPACs appropriate?
Jan Robertson’s (Managing Partner & CEO SiVal Advisors LLC) recent session gave a fascinating insight on SPACs. I am echoing some of her insights here to write about when the SPACs are appropriate. The two essential points that come to my mind are stated below.
1. When Private companies are reportedly less sure that they will be able to raise large rounds soon but still need access to capital. Some are looking for public markets for liquidity but do not have enough time to go through traditional IPO’s excruciating and time-consuming process.
2. COVID-19 pandemic has injected uncertainty into the market and delayed the traditional IPO process significantly. Private companies are eying for the available option, i.e., SPAC to raise capital from the public.
Market concerns in adopting SPACs
SPAC traditionally had a bad reputation in the 90s when it was compared with penny stock fraud. Some grievances still hold at this time and are stated below.
1. Risky Investment
a. There is no underwriters or underwriter counsel to serve as “the second set of eyes.” SPAC personnel and counsel involvement is less rigorous
b. Initial investors are betting on the sponsor, not on the company
c. SEC involvement is minimal
d. Nikola fraud has again raised suspicions about SPACs
2. Expenses for the target company
a. Sponsors pay nominal amounts for 20% of the SPAC shares before the acquisition. This leads to a costly loss of equity for the target company
3. Time Constraints
a. Sponsors usually have two years to find and acquire a company. If the deadline is approaching, the sponsors rush to find a viable company to acquire
i. In that case, SPAC may entice companies that need cash fast, which can lead to worse results for investors
4. SPAC Boom
a. As SPACs are gaining more popularity, there may be too many SPACs and not enough companies to acquire, which could cause the SPAC trend to crash
(CBS Insight SPAC Pros Cons, 2020)
Works Cited
CBS Insight. (2020). Retrieved from Investment Trends: https://www.cbinsights.com/research/report/what-is-a-spac/
CBS Insight SPAC Pros Cons. (2020, Nov 5). Retrieved from CBS Insight: https://www.cbinsights.com/research/spac-pros-cons/
Hindenburg Research. (2020, Sept 10). Retrieved from Nikola: https://hindenburgresearch.com/nikola/
Investopedia. (2020, Aug 3). Retrieved from https://www.investopedia.com/terms/s/spac.asp
Market Watch. (2020, Sept 16). Retrieved from Market Watch: https://www.marketwatch.com/story/2020-is-the-year-of-the-spac-yet-traditional-ipos-offer-better-returns-report-finds-2020-09-04
Nasdaq. (2020). Retrieved from https://www.americanbar.org/groups/business_law/publications/blt/2020/07/spacs-litigation/
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