Forget the pandemic. Forget the recession. Investors are tripping over themselves to put their money in companies that will soon become public, and these companies are more than happy to try to list on public markets. And for that, most are not following the traditional route of an initial public offering, or IPO. They are looking for something faster: a SPAC.
The term SPAC means a special purpose acquisition company, which is essentially a publicly listed pile of money intended to buy a private company. SPACs have become the main listing maneuver for companies on the stock exchange. Some see these vehicles as a smart way to invest in newly opened companies, while others say the unbridled enthusiasm for these financial products has similarities to the dot-com boom and bust two decades ago. In fact, the word “bubble” continues to bubble around SPACs. And new SPACs are emerging every day.
In the first two months of this year alone, 189 SPACs were listed on major stock exchanges, according to data from University of Florida professor and IPO expert Jay Ritter. At an annualized rate, that would mean more than 1,000 SPACs in 2021 – more listings than any year in history for SPACs and traditional IPOs combined. In early March, SPACs raised $ 64 billion, according to the financial markets platform Dealogic, $ 20 billion before the record total of 2020. That means huge stacks of money to invest in mergers with private companies.
Once an obscure investment vehicle, SPACs are seeing the interest of retail investors: normal people who do not invest for a living, like those who trade at Robinhood. They were stimulated by pandemic boredom and stimulus checks, as well as a series of recent high-profile SPACs that performed unusually well, such as DraftKings.
There are several pros and cons to SPACS and a variety of ways in which the SPAC boom can develop, especially now that there is a growing interest from retail investors. So, here’s what you need to know about the most popular type of stock on Wall Street.
What is a SPAC?
SPAC is a front company that goes public with the express purpose of raising money to buy a real company (or companies). This effectively brings the company’s public operational more quickly than through an IPO. A SPAC has two years to find a private company to merge or return investors’ money.
People can invest in SPACs in the same way as they would with any other stock, but until it merges with another company, there is no way of knowing if this is feasible. And when these mergers are announced, the companies involved are often not only unprofitable, they don’t even generate revenue. Unlike normal shares, however, people can go out of business and redeem $ 10 guaranteed per share before the merger is finalized, so if they paid close to $ 10 per share, they have little to lose if they don’t like the merger.
This year, several high-profile SPACs went public, including Churchill Capital IV, which recently announced that it was merging with Lucid Motors, an electric vehicle company that has yet to manufacture a vehicle. The stock traded at $ 64 before the early announcement and is now around $ 24, suggesting that investors were disappointed by Lucid’s production schedule or the terms of the deal.
Who wins / loses money with SPACs?
SPACs are created by a sponsor, usually an industry executive, who places about $ 5 million to $ 10 million of his own money in exchange for about 20 percent of the shares in SPAC, which normally owns a minority stake. in the merged company. If SPAC finds a company to merge at a good price, the sponsor can earn tens or even hundreds of millions of dollars. If SPAC does not complete an attractive merger, the sponsor may lose its initial investment.
Still, even if investors lose money, the sponsor can still make a lot of money. Michael Ohlrogge, a New York University law professor who researches SPACs, estimated that the sponsor of Clover Health, which was negotiating earlier this week at the initial bid price, still won about $ 150 million.
In addition to having the opportunity to buy SPAC shares for $ 10 each – and sell them back at that price if they don’t like the company – early investors can also maintain a stock guarantee, which gives them the right to buy shares at a price set over the next few years. Ohlrogge compares this to timeshare offering free flights to give people their pitch, with the hope that these people will decide to buy the timeshare (if they don’t, they will still have free flights).
“It’s wonderful for the people who do it,” he told Recode. “It’s free money.”
The situation is not so encouraging for regular retail investors, who can only buy SPACs when they reach the public markets, when the price is usually more than $ 10. The further the price is $ 10, the more retail investors have to lose, even before the merger closes. For example, if you buy a SPAC for $ 15, but you don’t like the merger, you will lose $ 5 if you try to redeem it instead of holding the shares. After mergers, SPACs have historically underperformed.
What is the difference between a SPAC and a normal IPO?
Both IPOs and SPACs are ways for a company to raise money. SPACs are a faster, but not necessarily cheaper, way to go public.
When you invest in a SPAC before merging with a private company, you are essentially investing in the SPAC sponsor, with the belief that SPAC will make a good merger. With an IPO, you know which company you are investing in. And in the case of Churchill Capital IV, people were investing in their sponsoring company and its track record of performing SPACs, as well as Lucid, which many speculated would be the target.
SPACs also receive less regulatory scrutiny than IPOs.
The main difference between SPACs and IPOs is how the companies involved can sell the business to potential investors. Due to an unintended legal loophole, SPAC sponsors – wealthy, usually high-profile, charismatic individuals – can make promises about their companies without so much legal responsibility, if those promises do not come true. In turn, these optimistic projections can help the company obtain higher assessments. Companies that do an IPO, however, are prevented by the Securities and Exchange Commission (SEC) rules from making claims about the future growth of their companies, making them “legally vulnerable to lawsuits in a way that SPACs are not, “according to Tulane commercial law professor Ann Lipton. It is much easier to convince people that a company is a good buy when you’re not stuck if those promises don’t come true.
Why are they so popular now?
Much has been written about SPACs recently and their popularity has generated more popularity. Last year, there were four times more SPACs than in the previous year, according to data from Ritter. This year, we are on the way to four times more than last year.
High-level SPACs, such as electric truck maker Nikola and DraftKings, have attracted the interest of institutional and retail investors. Popular SPAC sponsors, including the first Facebook executive and the so-called SPAC king Chamath Palihapitiya, as well as a series of celebrity endorsements, including those from Jay-Z and Steph Curry, have made investing in SPAC even more attractive.
“There is a very strong appeal among people that there is an intelligent person making investment decisions on their behalf and that it will bring them a lot of money,” said Ohlrogge of NYU.
In addition, many SPACs are looking for mergers in popular sectors such as electric vehicles, where investors hope to replicate gains like Tesla, whose share price has risen more than 1,000 percent in the past two years.
“I think it is partly a case of investors chasing past returns,” Ritter told Recode. “The past few months have been very good for SPAC investors, and the money tends to follow previous returns.”
The stock market is also doing well now and, as Bloomberg’s Matt Levine noted, SPACs are seen as a way to capitalize on current market conditions to go public in the future, when conditions may not be so good .
What’s the catch?
If investors put their money in SPACs and hold those shares after the merger, they are likely to lose more money, on average, than if they invested in regular IPOs.
While SPACs can be a sure thing for institutional investors who can buy shares for $ 10 and redeem their money if they don’t like the eventual merger, the value proposition is less clear to those who come in later. In a study of nearly 50 SPAC mergers in 2019 and 2020, Ohlrogge found that a year after the mergers, returns on SPACs were almost 50 percent lower than for a basket of IPOs. Ohlrogge also found that about 97% of those who bought SPACs on the IPO redeemed or sold their shares at the time the merger was closed.
What happens next?
SPACs can fall victim to their own popularity.
“Now there is so much money behind business that it will be increasingly difficult to engage in attractive mergers,” said Ritter.
This may mean that SPAC sponsors will have to eat up their investments if they do not find a good merger. If the historical performance of SPAC is any indication, investors in companies that carry out mergers and go public are also not necessarily safe. Even the people who benefit from the SPAC boom are wary. David Solomon, CEO of major SPAC underwriter Goldman Sachs, said earlier this year that the trend is not “sustainable in the medium term”.
SPACs may also undergo more regulatory scrutiny as the SEC takes a closer look at how they operate and how they are understood by retail investors.
For now, SPACs are in a very busy space, but when the buzzing stops, they can hurt.