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The Epic Rise and Fall of SPACs
How 2020 and 2021 were blockbuster years for SPACs but led to lackluster returns
What’s a SPAC?
SPACs aren’t very complex but to understand the Trend to Watch, you’ll need to know a few things about them.
A special purpose acquisition company (SPAC) is formed to raise money through an initial public offering (IPO) to buy another company.
At the time of their IPOs, SPACs have no existing business operations or even stated targets for acquisition.
Investors in SPACs can range from well-known private equity funds and celebrities to the general public.
SPACs have two years to complete an acquisition or they must return their funds to investors.
In creating a SPAC, the founders sometimes have at least one acquisition target in mind, but they don't identify that target to avoid extensive disclosures during the IPO process. (This is why they are called "blank check companies." IPO investors typically have no idea about the company in which they will ultimately be investing).
The funds SPACs raise in an IPO are placed in an interest-bearing trust account. These funds cannot be disbursed except to complete an acquisition or to return the money to investors if the SPAC is liquidated.
If you’d like to read a more friendly, detailed version that I found super helpful, click here.
Now to the good stuff.
Believe it or not, SPACs aren’t any new thing. In fact, this financial mechanism has actually been around for quite a while. SPAC IPOs raised $13.6 billion in 2019, which was more than 4x the $3.2 billion they raised in 2016. But SPACs really took off in 2020 and 2021, with as much as $96 billion raised from 295 SPAC IPOs in just the first quarter of 2021, surpassing the previous high of $80 billion from 248 SPACs for all of 2020.
It seemed that many saw SPACs as a way to get in on companies much younger in their infancy than having to wait for them to mature and go public the traditional way. This allowed many high-profile companies like Draftkings DKNG 0.00%↑, Virgin Galactic SPCE 0.00%↑, and Nikola NKLA 0.00%↑ to gain access to the public markets with their high-flying stories of changing the world.
With quarantine still happening in the US, and people staying at home with savings built up during the pandemic, billions of dollars were thrown at these companies in an effort to be a part of the next big thing. Many of these SPACs were also promoted by celebrities in order to build the legitimacy of the company and its vision.
Basketball Hall of Famer Shaquille O’Neal, Golden State Warriors player Stephen Curry, tennis champion Serena Williams, and former pro baseball player Alex Rodriguez are some of the notable professional athletes who have been involved in SPACs in some capacity. Former San Francisco 49ers player Colin Kaepernick, now an activist, also formed a SPAC focusing on social justice.
It seemed like easy money for SPAC sponsors to get a deal going, collect on absorbent fees and the potential windfall once the SPAC merged. During the beginning of the year, it almost seemed like stocks really did only go up, but that proved wrong when things started to tip in mid-February.
With such a euphoric and meteoric rise that SPACs had, a bubble seemed to be brewing.
Slowly but surely, things started to fall apart for most SPACs. One benefit that SPACs get over traditional IPOs is that they are allowed to publicly forecast their financials five years out to give the public some guidance on where they are headed. By default, you’d want to show some pretty optimistic financials if you’re raising money, and hence why many SPACs seemed to provide projections that almost seemed too good to be true.
Spoiler alert. They were.
SPACs are getting hit by a rising number of class-action lawsuits as more hyped-up deals turn out to be flops.
Shareholder lawsuits against post-merger special purpose acquisition companies rose to 15 through the first half of 2021, tripling from just five in all of 2020, according to data from Woodruff Sawyer. The jump came even as overall securities cases fell 13% this year, according to the data.
While many of these suits could be dismissed in court, some have resulted in punishing settlements. In April, music streaming company Akazoo S.A. settled two security lawsuits for an aggregate amount of $35 million, and the stock was delisted from the Nasdaq.
Investors are trying to hold SPAC leaders accountable at a time when regulators are stepping up their oversight. The SEC has repeatedly warned investors of underlying risks in investing in corporate shells, while demanding better disclosures and tighter accounting rules from blank-check deals.
CNBC has a post-SPAC index that analyzed SPACs post their “de-SPACing” (merging with their target company) to measure their performance.
YTD, the CNBC index is down over 38% as of the market close of December 16th. This reduced degree of oversight from regulators, coupled with a lack of disclosure from the typical SPAC, meant that retail investors ran the risk of being saddled with an investment that could be massively overhyped or occasionally even fraudulent.
Strategists at Goldman Sachs noted in September 2021 that of the 172 SPACs that had closed a deal since the start of 2020, the median SPAC had outperformed the Russell 3000 index from its IPO to deal announcement; but in the six months after deal closure, the median SPAC had underperformed the Russell 3000 index by 42 percentage points. As many as 70% of SPACs that had their IPO in 2021 were trading below their $10 offer price as of Sept. 15, 2021, according to a Renaissance Capital strategist.
This guy that I came across on Twitter actually published a SPAC tracker of 236 SPACs, post-merger, and their 52-week performance. If you like seeing only red, click here.
Celebrity Status ≠ Quality
But what happened with all the celebrity-sponsored SPACs?
Short answer. Not much good. 21 out of 33 SPACs tied to famous public figures have posted negative returns for 2021.
Not counting the SPAC tied to former President Donald Trump, which minted a phenomenal gain of more than 400%, the rest of the group averaged an 11% drop through Dec. 13, with rapper Jay-Z’s 84% plunge the worst of the bunch. Only two managed gains of more than 10%, trailing far behind the S&P 500’s 25% rally.
It’s a stark and expensive lesson: While an A-list person can attract attention for a blank check company amid a $155 billion glut of new offerings, it hardly ensures superior returns.
Fuel to Fire
What’s worse is that there is actually too much money chasing too few opportunities. As per SpacTrack, over 500 SPACs are currently going around looking for businesses to acquire.
If lots of SPACs are looking for deals, there aren’t many private companies that want deals. Hence, too many SPACs and too few good, quality businesses.
Additionally, redemption rates are soaring. Redemptions are where shareholders of the SPAC seek their money back rather than hold stock in the merged company. Redemption rates across the market were about 10% earlier this year but had grown to 70% by November. That reduces the amount of capital the merged company retains.
With less money, some companies might not be so viable to continue operations and will have to issue a secondary offering and further dilute their shareholders. Yay! said no one.
SPACs can be used for good, *queue cheesy Spiderman reference*, but seems like 2021 has proven the opposite. I myself have been hit by two SPACs, BARK 0.00%↑ (which literally makes me want to rip my hair out because the business is solid) and Weedmaps MAPS 0.00%↑.
Though I have had SHORT calls on Virgin Galactic SPCE 0.00%↑ and AppHarvest APPH 0.00%↑, down 52.6% and 66% respectively. This has led me to start targeting SPACs that could yield high returns. I’ve listed a few below and their investor decks that I will be looking at over the holidays.
Regardless, please stay safe out there and make sure to do your research before you invest in SPACs or you could be left with a very bad dent in your portfolio. If you’ve been hit by a SPAC, leave a comment below, I’d love to hear about it.
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