18 May 2021
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SPACs (Special Purpose Acquisitions Companies) have been around for years and were generally seen as a last resort for small companies struggling to raise money on the open market but, in a volatile market, they’ve recently emerged as one of Wall Street’s hottest trends.
So, what is a SPAC and how does it work? A SPAC is basically a shell company set up by investors with the purpose of raising money through an IPO (Initial Public Offering) to acquire another, yet untargeted company, at some point in the future. A SPAC doesn’t make or sell anything, and the money raised in its own IPO is its only asset.
A SPAC is generally created by a team of institutional investors with a successful track record - since they are more likely to have the power to convince people to invest in the unknown. Once the IPO raises capital (SPAC IPOs are generally priced at a nominal $10 a share), the money is put into a trust account until a suitable company is found. If shareholders don’t like the acquisition put forward by the management team, they can vote to turn down the proposition. If a merger does complete, investors can either swap their shares for shares of the merged company or redeem their SPAC shares with interest from the time the money was in the trust.
What are the trading rules around SPACs in different countries? In the US, shares aren’t suspended if there’s a merger going on but in Europe, shares are suspended during this process and investors can’t trade. Any shares in a cash shell are held until the merger completes and then the shares are listed again. In Sweden they are changing the rules so that when mergers are proposed, trading can continue, which facilitates the recent SPAC mania present in the market.
Last year SPACs really took off and cumulatively $80 billion was raised, which is comparable to the total raised over the last 4 to 5 years. Why have SPACs grown exponentially? More and more people are getting involved in the stock market and because SPACs aren’t as regulated as most vehicles, a lot of companies are capturing the imagination of millennial investors. More retailers are getting involved, spiking the interest of institutional investors, adding credence to the whole concept. Bernard Arnault, head of LVMH and Jean-Pierre Mustier, a UniCredit banker, have their sights firmly set on a fintech company and have launched Europe’s biggest SPAC raising around 500 million euros.
What’s so attractive about SPACs? They are flexible, transparent and widely accessible compared to the IPO process. With an IPO, there’s a requirement to publish previous accounts and financial statements and you’re not allowed to make forward looking statements that you can’t back up, but with SPACs you can sell the whole story; what you’re looking to do and what you’re aiming to achieve. This approach might not gain approval from the Dragon’s Den investors, but some SPACs are led by experienced deal makers who are talented at spotting potential and there’s a built-in safety net as shareholders can get their money back if they don’t like the deal offered.
Are there any downsides to SPACs? Some may suggest that management is incentivised to do a deal because they get free shares in the new business and, with a 2 year limit, there’s a concern that they could dive into poor acquisitions just to get the deal over the line. The amount of capital that sits in SPACs could mean that sponsors won’t be able to find suitable targets and could push them towards companies of questionable value. The SEC (Securities and Exchange Commission) aims to protect investors and is starting to question the regulatory space for SPACs. There’s concern that celebrity endorsement will create a credible image that could be soaked up by retail investors and they’re looking to clamp down on the production of forward-looking statements that are so out of sync with what a company's business model is or might be.
In 2020, SPACs shook off the negative image but it’s now returning like a bad penny. In February and March, the prices of SPAC companies took a tumble due to selling in the markets; story stocks and the high-flying technology stocks that were in vogue have started to deflate. According to a Financial Times analysis of Refinitiv data, of the 13 SPACs that have announced acquisitions in May, only one is trading above $10. Why the sudden shift in enthusiasm for SPACs? It could be down to retail traders turning their attention to alternative assets such as cryptocurrencies and to institutional investors withdrawing from the market.
Some may say that SPACs let the next generation investor in on the deals to take ambitious and innovative companies public whereas others might suggest that investors going blindly into an investment is a fools’ game. It’s probably no coincidence that SPAC fever started to wane when the SEC got involved. Without evidence of financial statements and accounts, is it a sound investment? Maybe story stocks have had their short-lived moment in the sun and a return to the ethos of the Dragon is on the cards…
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