Is the SPAC market heading for a crash?

A special purpose acquisition company (SPAC) is a listed shell company designed to raise capital in order to take another company public. Known as blank cheque companies, investors are reliant on the financial acumen of a SPAC’s management to identify the right opportunity.

SPACs have seen a meteoric rise as pandemic-hit companies looked for alternative ways to raise capital. According to data from Dealogic, SPACs racked up $34.9bn in new issuances in February, making the $9.3bn from traditional IPOs seem almost paltry by comparison.  

The frenzy has led to SPACs endorsed by celebrities like Shaquille O’Neal and launched by the business world’s big names, like Richard Branson and Bill Ackman. In his latest Opto column, veteran investor Frank Holmes notes that SPAC listings overtook IPOs last year:

“[In 2020] 248 SPACs listed, a record, compared to 209 traditional initial public offerings (IPOs). To my knowledge, this is the first time SPAC issuances outpaced IPO issuances.”

“[In 2020] 248 SPACs listed, a record, compared to 209 traditional initial public offerings (IPOs). To my knowledge, this is the first time SPAC issuances outpaced IPO issuances” - investor Frank Holmes

 

For Holmes, SPACs make it easier for a company to go public through an acquisition or reverse merger, as there are fewer regulatory hoops to jump through. They are also less costly than a traditional IPO. However, Holmes says he “wouldn’t be surprised if regulators start to crack down on these types of transactions”.

Recent reports in both Al Jazeera and the Financial Times back up Holmes’ concerns. In separate stories, the two news outlets report that the US Securities and Exchange Commission has requested information from those involved in the listing of these “blank cheque” companies. The Financial Times notes that, while banks and law firms have “enjoyed lucrative rewards and fees” from SPACs, critics have been increasingly vocal over investor protection and incentives.  Al Jazeera reports that the regulator is concerned about underwriting the flood of deals coming from SPACs.

“This is the beginning of what I expect will be heightened scrutiny of trading and disclosures to investors arising from the surge of these transactions,” Doug Davison, a partner at Linklaters, told the Financial Times.

“This is the beginning of what I expect will be heightened scrutiny of trading and disclosures to investors arising from the surge of these transactions” - Doug Davison, partner at Linklaters

 

Are SPACs overvalued?

As valuations outpace the underlying fundamentals, there’s a danger that the SPAC boom is turning into a fad, with investors getting burnt in the process. The past month was particularly sobering, as the rise in treasury yields has caused a selloff in the market, with the IPOX SPAC Index experiencing an extended selloff at its February peak. Chamath Palihapitiya — a name now synonymous with blank cheque companies — even commented that “The SPAC market has taken a real beating,” on his podcast.

“When the price is moving up way faster than fundamentals can justify, that screams risk to us, and people who have those exposures are experiencing that risk today,” Matt Stucky of Northwestern Mutual Wealth Management told Bloomberg. 

Worryingly, the downturn in the performance of these investment vehicles has been more pronounced than the one seen in the wider market. A 9 March report from CNBC cites Bain & Co data showing that 60% of SPACs are lagging behind the S&P 500.

“When the price is moving up way faster than fundamentals can justify, that screams risk to us, and people who have those exposures are experiencing that risk today” - Matt Stucky of Northwestern Mutual Wealth Management

 

Taking a look at The Indxx SPAC & NextGen IPO Index, its top three holdings have all taken a bruising. Top holding DraftKings [DKNG] is down 15% over the past month and second-place Open Technologies [OPEN] has seen a steep 33% decline (as of 30 March’s close). In third place is Bill Ackman’s investment vehicle Pershing Square Tontine Holdings [PSTH] which has seen an 18% drop.

“There have been too many new issue listings and the market simply cannot handle the overflow,” Christopher Matthaei, a partner at Elevation Securities, which conducts SPAC research, told Al Jazeera.

 

Where next?

Greater scrutiny means greater investor protection, and it’s unlikely that the SPAC will go away anytime soon — the City of London is already looking at how it can make it easier for SPACs to list so it doesn’t lose business to New York or Amsterdam.

SPACs are a way to raise cash for a listing, especially for innovative companies at a time when capital markets are under pressure. For example, Virgin Galactic listed via a SPAC. 

  

One route for those interested in SPACs could be to consider a fund that gives exposure to the overall SPAC market. For example, The Defiance Next Gen SPAC Derived ETF [SPAK] is down 16.42% over the past month. The fund gives a 60% weighting to IPO companies derived from SPACs and 40% to newly listed, pre-merger SPACs. So, while some of its constituents have taken a beating over the past month, investors aren’t nursing the same heavy losses as if they’d invested in individual SPACs.

The other route to exposure is waiting for a SPAC to complete. After all, the end result is still a listed company that can be assessed at a fundamental level.

Either way, the old adage of doing homework before investing applies as ever.