almost 3 years ago • 3 mins
Special-purpose acquisition companies (SPACs) are in high demand among investors – but that very popularity could be creating some major drawbacks.
✍️ Connecting The Dots
First off, a quick reminder: SPACs are companies specifically designed to list on a stock market and raise money from public investors. They don’t have any business operations themselves – instead, SPACs’ sole aim is to find other (usually private) companies to merge with and effectively morph into. These “blank-check companies” offer an alternative to an initial public offering (IPO) for SPAC targets: they end up listed on the stock market, only without all the administrative headaches and expenses involved in a standard IPO.
Although SPACs have been around for decades, their popularity rocketed last year: such companies accounted for almost half of all IPOs by volume in 2020. And the SPAC surge has ratcheted up in 2021: blank-check companies raised more in the first three months of this year than they did in the whole of 2020, giving investment banks a fee bonanza.
Investors’ enthusiasm stands to reason: borrowing is cheap but stocks are expensive, and market-beating returns are hard to come by. SPACs are particularly interesting because they allow retail investors the chance to participate in private equity-type transactions that are otherwise largely inaccessible.
Still, no investment is without its drawbacks. As no one knows what the eventual acquisition target of the SPAC will be when it goes public, any potential returns are entirely dependent on the ability of the SPAC’s managers to identify and negotiate a good deal. What’s more, SPACs’ track record is choppy: analysis shows that of the 89 listed between 2015 and July 2020, only 26 delivered positive gains.
1. Two aspects of SPACs have spooked financial regulators
With popularity comes scrutiny: US regulators have already warned investors against buying into SPACs based on celebrity endorsements. And it seems they’ve got beef with two other more structural issues, too. Authorities are concerned about whether SPACs do enough research before they buy target companies, as well as the risk of insider trading in the period between the SPAC’s stock market debut and the announcement of a merger target. The experience of blank-check companies’ mid-2000s boom – and bust – may be salutary.
2. SPACS are only safe for initial backers
Goldman Sachs said in January that SPACs are one of three areas in US markets that look particularly bubbly. While investors used to snap up SPAC shares only after rumors about a potential merger appeared, by the start of this year they were driving up prices even when no potential deal was in sight. While there’s a theoretical floor on SPAC investors’ potential losses – if it doesn’t find a deal, shares should get bought back at the original IPO price – big risks remain for those who buy in at the peak of a rally. Maybe investors are getting the message: those first-day trading pops faded last month.
🎯 Also On Our Radar
Bill Ackman had hoped last summer’s SPAC would find a merger target by the end of this past quarter – but he was forced to admit last week that this self-imposed deadline would be missed. Still, that hasn’t stopped Bill from mooting the launch of a second SPAC…
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