The red-hot SPAC market is getting even hotter in 2021, raising concerns about rampant speculation unrelated to the reason that could leave retail investors fresh out of the GameStop bust holding the bag.
Not only are special-purpose acquisition companies raising a record level of capital – more than $ 30 billion so far for the biggest quarter of all time – pre-merger SPACs are also having a huge burst on the first day of trading .
The new businesses this year registered an average jump of 6.5% in their debuts, an increase of almost six times in relation to historical levels (from 2003 to 2020, the average return of SPAC IPOs on the first day is only 1, 1%), according to the University of Jay Ritter, professor of finance in Florida.
“Each of them has increased in price. It is not driven by one or two outliers,” said Ritter.
Unlike traditional IPOs, where debut bursts are generally seen as a sign of healthy investor appetite and optimistic market environment, SPAC’s initial recoveries are less rational in nature. These blank check companies are empty corporate shells that raise money from investors and then merge with a private company in two years, while making it public.
So when income-hungry investors raise business prices with blank checks, they are essentially taking a leap of faith, betting on something without valuation or a real deal. Many believe that the rise in SPAC prices may be a sign of speculative behavior in a new bull market, with massive liquidity and uncontrolled animal alcohol.
“There is a lot of money coming into the market,” said JJ Kinahan, chief market strategist at TD Ameritrade. “This lends itself to people who are off the course of the S&P 500 or Nasdaq 100. You will continue to see this behavior just because people are looking around to see what else exists besides buying the same stocks that everyone else is buying. . “
Retail investors taking action
There are signs that the SPAC boom is engaging in the market frenzy fueled by retailers. Bank of America’s customer flows showed that retail investors accounted for 46% of the trading volume in SPACs on its platform in January, up from about 30% two months ago. In comparison, the retail crowd occupies only about 20% of the S&P 500 trades on the Bank of America platform.
“The speculative nature of SPACs appears to be particularly attractive to retailers,” Bank of America analysts said in a note. “We definitely don’t need to remind anyone what can happen when something speculative comes on the retail radar (ahem, GameStop).”
There is a fascination with getting an early part of a SPAC deal for many retail investors who are looking to high-growth start-ups. However, as most individual investors buy SPAC common shares on the open market, they would likely miss the first day’s pop. In addition, many brokers do not offer SPAC subscription bonus trading, which is a business sweetener that offers initial investors more compensation for their money.
In fact, investors who buy and hold, who only enter the business after the deal is closed, almost always lose money.
For the 114 companies that went public through SPAC mergers over the past 10 years, investors lose 15.6% on average if they buy common shares in a company incorporated on the first day of trading and hold for a year, according to Ritter. And they lose an average of 15.4% if they stay with the shares for three years.
However, it is a different story for institutional investors. Hedge funds and other participants participating in SPAC’s IPOs are generally able to obtain an offer price of $ 10 plus the benefit of warrants. They also tend to sell shares when the merger is completed, which can have a negative impact on prices.
“Institutional buyers have found this to be a great deal,” said Ritter. “SPAC’s IPOs are essentially undervalued default-free convertible bonds. The worst they can do is $ 10 plus interest, and no one has lost money.”
Competitive assessments
Another worrying factor is the large number of businesses currently chasing targets. A record of more than 300 pending SPACs is at stake, giving private companies more bargaining power and allowing them to pit investors against each other for better valuation.
“Of course, the ratings have become increasingly competitive,” said Soumya Sharma, corporate attorney at Troutman Pepper. “The only reason this is going to survive is that the top targets are agreeing to merge with the SPACs because they believe they are being valued more.”
As the valuations of the target companies increase, this reduces the potential for upside for SPAC investors. In the meantime, sponsors may be competing for substandard companies, many of which have yet to produce a physical product.
“The past two months have been great for SPAC investors, with returns being very high, but I don’t think it will be able to continue that way,” said Ritter.
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