Who will be the sucker? Even the SEC, which is dormant during all of this, warns retail investors. But in the current craze for megabubbles, no one gives a damn about anything else.
By Wolf Richter for WOLF STREET.
SPACs – Special Purpose Acquisition Companies, or more descriptively, “blank check companies” that do not have operations – have accomplished a great feat that fits perfectly into the current mega bubble craze.
So far this year, as of today, 260 SPACs have gone public and raised $ 84 billion from their IPOs, according to data provided by SPACInsider. This is a great moment because it has passed the total amount collected during the whole year of 2020 of $ 83 billion, which in itself was six times higher than the previous record of the whole year in 2019. At this rate, the SPACs are forming the next WTF chart of the year:
At the IPO, a SPAC sells shares and guarantees that are then negotiated separately. SPACs have no operations at this point. They are an entity filled with the funds they raised in the IPO, looking to acquire a company, such as a startup, usually within two years. After the acquisition, if approved by investors, SPAC changes its name to the name of the startup and changes its ticker. In this way, the startup can go public, avoiding the arduous disclosures and scrutiny that a traditional IPO process entails.
This arduous scrutiny was put in place to protect investors from the IPO. However, investors no longer care about the protections in the current mega bubble craze. Nobody cares about anything anymore, as long as that stuff goes up. See cryptos and NFTs, as well as SPACs.
Dozens of SPACs that went public this year and at the end of last year were created or used as leading figures of athletes, Hollywood celebrities, celebrities of all kinds, former Mayor Paul Ryan, former secretary of Commerce Wilbur Ross and, of course, Larry Kudlow, rapper Jay-Z, Gary Cohen, who was also chief economic adviser to President Trump for a while, and Chamath Palihapitiya, a former Facebook executive and current merchant god who frequent Reddit and Twitter, which has listed six SPACs so far.
To be someone, you have to create a SPAC and sell the shares and guarantees, and list it, and ride the SPAC bubble and attract retail investors.
The SEC warned retail investors about SPACs last week, yes, the SEC that slept through it all and is still asleep.
“SPAC transactions differ from traditional IPOs and have distinct risks associated with them,” said the report. “For example, sponsors” – celebrities, former politicians or other sponsors – “may have conflicts of interest, so their economic interests in SPAC may be different from those of shareholders”.
“SPAC sponsors generally acquire a stake in SPAC on more favorable terms than investors in the IPO or subsequent investors in the open market,” the document said. “As a result, sponsors will benefit more than investors from completing a business combination through SPAC and may have an incentive to complete a transaction on terms that may be less favorable to you.”
“Even if a celebrity is involved in a SPAC, investing in one may not be a good idea for you,” he said.
The SEC also sent a series of tweets in the jungle at the Investor Advisory Committee Meeting on March 11, which included more bits and pieces:
“As the SPACs’ transaction volume reaches unprecedented levels, the team is closely examining the structural and disclosure issues surrounding these business combinations.”
“We are seeing more evidence on the risk side of the SPACs equation as we see studies showing that its performance for most investors is not overkill.”
“Many investors and commentators misinterpret SPACs and their costs, especially the role of warrants and redemptions in increasing SPAC costs, and how merger deals can make investors bear SPAC costs.”
“The SPAC panel is considering the implications of current market trends under evaluation, acquisition targets, alignment with conflicts of interest, quality of disclosure and litigation.”
One of the issues is the special treatment that IPO investors receive that retail investors do not: when they buy shares in the SPAC IPO, thus financing the SPAC, they obtain the right to withdraw their funds before the closing of the eventual acquisition. In other words, they can choose to get all of their money back. This isolates them from losses.
Therefore, if a SPAC that went public at $ 10 per share six months ago announces an acquisition and its shares plummet, the hedge fund that bought the shares during the IPO has the option of withdrawing its initial investment.
Retail investors can sell their shares on the market and eat the losses because they have no protection against losses.
Therefore, a hedge fund buys the shares on the IPO and, months later, when an acquisition is announced and the shares go up, the hedge fund can sell the shares on the market and pocket the profit. But when stocks plummet with the announcement of the deal, the hedge fund has the right to withdraw money from the initial investment before the deal closes. In other words, they are based on a risk-free investment with high return potential.
But retail investors who bought the shares on the market are able to eat the losses. And the SPACs did not do very well. Despite the mega-bubble, Defiance Next Gen SPAC Derived ETF [SPAK] fell 14.5% in the last four weeks.
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