Question of the Month
This is where we answer the best investment question we’ve heard all month. If you’d like your question to be considered, please send it to us.
What are SPACs and why are they suddenly hot?
SPAC, which stands for a special purpose acquisition company, is a “blank check” shell company that exists for the sole purpose to take companies public without going through the traditional IPO process. According to the SEC, they are created specifically to pool funds in order to finance a merger or acquisition opportunity within a set time-frame, which is usually has yet to be identified.
So how does it work? Essentially, an asset manager tells investors, “Look, I see some opportunities in the private markets. I’m an expert and if you lend me some money, I’ll make it worth your while.” SPAC issues an IPO, which is as transparent as can be because it’s all cash. For example, they can raise $300M and issue 30M shares at $10 each. After that they go hunting for private companies. If they’re able to find a suitable target, they complete a merger, in which case the SPAC shareholders get shares in the target company, effectively taking it public. If no suitable target is found within allocated time-frame, as specified by its charter, the SPAC dissolves, returning the original investment to its shareholders.
So how is that different from IPOs? Actually, in two very important ways. First, it allows the private company to bypass the scrutiny of the regulators and initial public investors that comes with IPO filing. It also saves time for investors and money for the target company, the insiders of which can typically also forgo the usual IPO lockup periods. The SPAC IPO has no complexities and its merger/acquisition only goes through a formality of a paperwork due to the nature of the shell corporation, although the SEC still must review and approve both. That is simultaneously the point of a major advantage and a target of a major criticism of SPACs. It also brings us to the second point: SPACs allow retail investors to invest in private equity type transactions, without paying high fees and avoiding all usual minimum investment and holding time restrictions. Investors also don’t need to worry about the exclusive nature of a typical IPO process, which most retail investors can’t get access to, not to mention fretting the downside risk.
SPACs have been around since the 1990’s but were an obscure form of an investment. They started a surge a few years ago, growing from $1.8B across 12 SPAC IPOs in 2014 to $13.6B across 59 SPACs in 2019. The number and value of SPACs exploded in 2020, with each consecutive quarter marking a new record. There were 77 SPAC IPOs in the third quarter alone, an increase of 185% compared to the 27 that debuted in the second quarter. The SPACs tended to be in the $100-$500M range; however, the largest SPAC IPO of 2020 is worth $4B. Gross proceeds for the quarter totaled $28.8B—more than double the money raised in the second quarter. The success or failure of this large class of SPACs likely determines the survival of this trend.
So why now and what makes SPACs hot? SPACs have remained popular notwithstanding the COVID-related market disruption, perhaps because of the flexibility of SPACs to pivot to attractive industries based on changing market fundamentals and sentiment, in addition to the reasons already mentioned above. And with 2020 being the year of a pandemic and a charged election, there was less incentive for companies to take on even more risk than the already inherently risky IPOs. The rise of the so-called “new retail investors” aka Robinhooders also helps facilitate an out-sized demand to get into those attractive industries both for the quick turnaround trade as well as for the long-term investment. Some of the themes that have received the highest investor demand when it comes to SPACs in 2020 include:
- Electric and autonomous vehicles and supporting industries such as battery makers, charging stations and car sensors
- Health Tech
- Green Energy
- Online Gaming