Is this the End for SPACs?

The Rundown – Your weekly SPAC Deep Dive (08/26/21)

Is this the End for SPACs? 

Short answer… No. But it’s an evolving market with a complex regulatory situation.

During the first four months of 2021, nearly 300 SPACs were listed with a combined value of $80 billion globally. This surpassed the figure for all of 2020, which itself had been a record-breaking year with $290 Billion of SPAC Mergers being completed. But this activity has slowed down considerably in Q2, with just 76 SPACs listing globally amounting to $14.6 Billion.

Many market participants believe that SPAC activity is now heading into a period of uncertainty after explosive growth. Special Purpose Acquisition Companies, which are also known as blank check firms, raise monthly through an IPO with the hopes of finding an appropriate target company to acquire within a limited time frame.

Once the target is acquired, it is merged with the SPAC and becomes publicly listed in a process called the de-SPAC. At this stage, initial investors of the target company are bought out by PIPE (Private Investment in Public Equity) investors, which results in a cash infusion in the company and helps improve the valuation terms of the deal.

SPACs are not a new phenomenon, but rather have existed for over three decades. But they have exploded in the last 18 months, particularly in the US where 90% of SPAC activity is taking place. 

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SPAC Underperformance 

Under the right circumstances, SPACs can create wealth for both sponsors and investors while being a great alternative to a traditional IPO. But there are several reasons for the steep decline in new SPAC listings and a slowdown in deals. First, there are regulatory concerns with indications from the SEC that most SPAC warrants, issued to sponsors, should be reclassified as liabilities, which could force a restatement of SPAC financials.

Second, there’s a general cooling off in equity markets, coupled with specific concerns that technology and high growth stocks are overvalued, especially with interest rates rising as inflation picks up. Finally, there are concerns with the performance of SPACs with most declining in value after the de-SPAC has taken place.

Post-merger performance has especially been a major concern for SPAC investors with many target companies projecting lofty revenues, only to revise them after the transaction. Only 14 of the 144 announced SPAC deals are currently trading over the IPO price of $10 a share.

The SPAC and New Issue ETF (SPCX), which invests at least 80% of its assets in SPACs is up by only 10.5% compared to 21% for the S&P 500. This signals that through active management and careful asset selection, one can still get an interesting return enhancer even in times of a market meltdown.

Jam-Packed Market 

The major risk that exists with the current market is that too many SPACs are chasing a relative shortage of attractive targets. Sponsors are rushing to get their deals down in an increasingly overcrowded market and are settling for lower quality target companies. Faced with intense competition, pressure to complete the deal within the deadline and a volatile market, some SPACs have had to settle for less than ideal targets and in some cases have thrown their entire blueprint out of the window.

Given the sheer number of outstanding deals, there are concerns that the quality of SPACs could deteriorate moving forward. Sponsors are concerned that they have to pay back the money to investors if they fail to find suitable targets, so they are looking to be extremely aggressive in their pursuits as far as to target companies in new markets including Europe and Asia.

Expansion into Other Markets 

SPACs are now expanding across Europe and Asia with favorable regulatory requirements and attractive targets ensuring lucrative opportunities for target companies and Sponsors.

Netherlands, Luxembourg, Italy and UK have all amended their listing rules to be more accommodative towards SPAC listings in recent months. SPACs are aggressively pursuing target companies in Asia in a bid to benefit from the high growth ahead.

There are tech-specific SPACs that are also popping up over the last few months, looking to specifically target companies in Singapore, Hong Kong and India with favorable regulations incoming. For target companies, it is an opportunity to raise higher capital compared to a domestic listing.

A prime example of this is Grab, which is now the worlds largest SPAC with a valuation of over $40 Billion. There are tech-specific SPACs that are also popping up over the last few months, looking to specifically target companies in Singapore, Hong Kong and India with favorable regulations incoming.

Rise of SPARCs 

With the looming uncertainty of SPACs due to a host of regulatory challenges and pressure to complete deals within a time frame, SPARCs have cropped up as a logical alternative, which could solve the current challenges.

In a SPARC, investors don’t put in the money upfront and instead receive a right to buy in once the vehicle announces a merger target, which isn’t subject to any time limits. Investors would buy in using their SPARC warrant at the Net Asset Value of the deal.

SPARCs have been popularized by Bill Ackman, who wants to convert Pershing Square Tontine (PSTH) into a SPARC to overcome the challenges of a traditional SPAC. The rise of SPARCs is beneficial not only to sponsors but to investors as well.

With enough time SPARCs can look for high-quality acquisition targets, instead of having to compromise to close the deal. Furthermore, since SPARCs don’t hold money while looking for the target company, it eliminates the substantial opportunity cost of capital that burdens all SPAC investors.

If the SPARC structure is approved by both the SEC and NYSE it could (drumroll) spark a regulatory shift in the entire SPAC market.

Bottom Line 

SPACs have been hit by a myriad of challenges over the last few months including regulatory challenges, lawsuits and pressure to complete deals quickly, resulting in under performance post the merger as a result of lower quality targets.

Two positive developments that might negate this in the future is the expansion of SPACs into Europe and Asia and the Rise of SPARCs. Just as how SPACs cropped up as a viable alternative to go public, there is a real possibility that SPARCs could do the same, but without the downsides that currently plague SPACs. In either case, There is no lack of institutional support of the SPAC market, as evidenced by a recent $500m fund raise by Apollo to invest directly in SPACs.

We think that due to the combination of outside factors that the SPAC market will continue to thrive over the long term. The underlying regulatory rules regarding SPACs will continue to shift, but the structure is here to stay. Investors now should be focused on SPACs with a higher quality of revenue streams and higher CAGR, versus some of the speculative pre-revenue companies that have gone public via SPAC over the last 12 months.


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