Bigger Isn’t Always Better: Why The SPACs Craze Is Getting Out Of Hand

Bigger Isn’t Always Better: Why The SPACs Craze Is Getting Out Of Hand
Carl Hazeley

over 3 years ago3 mins

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What’s going on here?

Last week brought yet another flurry of investment activity involving special-purpose acquisition companies – a.k.a. SPACs. But for those considering taking the plunge and backing a buyout vehicle, it’s worth first understanding exactly what all the hype is about – and whether the reality truly resembles sky-high expectations.

What does this mean?

First, a reminder: SPACs are companies specifically set up to list on a stock market and raise money from public investors. They don’t themselves take any revenue or make any profit; instead, SPACs’ sole aim is to find other (usually private) companies to merge with and effectively morph into.

SPACs are tried-and-tested investment vehicles: you might remember space travel company Virgin Galactic “went public” last year by merging with an already-listed SPAC, allowing anyone to purchase the previously private firm’s shares. Their price has since more than doubled.

2020, however, has seen SPACs hit the mainstream: 201 have listed so far this year, with 200 doing so in the US – accounting for over half of the country’s initial public offerings (IPOs). That’s almost three times the number of SPACs that listed last year, and ten times more than in 2015.

The number of SPACs per year
This year’s SPAC boom has been huge (Source: SPACInsider)

And the trend shows little sign of slowing down. Just last week, SPAC Subversive Capital announced a merger with cannabis company Caliva, which boasts entrepreneur and rapper Jay-Z as its “chief visionary officer”. The billionaire founder of French telecoms company Iliad meanwhile announced he was aiming to raise $360 million for a SPAC dedicated to pursuing consumer industry deals with a sustainability angle – such as eco-friendly household products or organic foods.

Why should I care?

Bigger isn’t always better, but it’s certainly eye-catching for investors seeking new ways to eke out profit from a stock market that’s never been higher – and SPACs have raised $70 billion so far this year. With the number and size of new SPAC companies rising, as well as new ways to invest in several of them at once springing up, it’s important for Finimizers to be aware of their essential strengths and weaknesses.

Average size of SPAC IPOs
SPAC IPO sizes are swelling (Source: SPACInsider)

📈 SPAC pros

SPACs allow everyday investors to participate in otherwise inaccessible private equity-type “leveraged buyouts”. A SPAC acquiring a company will typically take on loans to fund part of the purchase price – the Iliad founder’s $360 million SPAC, for instance, is aiming to spend around $2 billion. This ability to use debt brings with it the potential for significantly higher profit, and therefore stronger returns for investors.

Because SPACs have no previous operations or financial data, however, the only way for investors to suss out their prospects of success is to look at the management team’s track record. Unfortunately, past SPAC performance is far from promising…

📉 SPAC cons

Investment bank Renaissance Capital recently analyzed 89 SPACs that listed between 2015 and July 2020 and have since found at least one company to merge with. Their shares showed an average return of -19%, with only 26 SPACs delivering positive gains. Compare that to the average +37% return investors have seen from regular IPOs since 2015 and you may get a sense of SPACs’ potential drawbacks.

“It’s a back door to going public and avoiding scrutiny,” argued a Renaissance analyst. “You hear about the moonshots, like DraftKings and Virgin Galactica, which have done well, but the average return is negative. You can’t just blindly go in and make money.”

Put another way, investing in SPACs isn’t for the fainthearted – nor the less-experienced investor. If you are interested in finding out more, however, check out our SPACs Pack – which should leave you in a better position to sort the better prospects from the bad.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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