Will SPACs keep up with the Hype?
Photo credit: Shutterstock
Right now, everyone seems to be talking about SPACs (special purpose construction companies). Pro basketball player Shaquille O’Neal is on his second SPAC, and House spokesman Paul Ryan is doing one as well. And with advanced companies like Virgin Galactic
SPCE
What’s behind door # 3?
Taking away the hype and detail, SPAC allows a company to list its shares on the public market and raise capital from new shareholders. The effects are the same as making a traditional initial public offering (IPO). As an investor, you could look at buying SPAC as buying an IPO. But you are not.
One problem is that you never know which company you are buying the IPO from. SPACs are formed as blank check capital construction companies. Only when the capital is raised will they identify a company to buy. It could be DraftKings. It could be Virgin Galactic. On the other hand, it could be Utz potato chips. When you buy the SPAC, you never know what’s behind door # 3.
Another problem is that your investment in that IPO is likely to be severely weakened. SPAC supporters (the people who organize it) usually take a large share – often 20 per cent – of the company at a much better price than SPAC shareholders.
SPAC transactions are different from traditional IPOs and there are certain risks associated with them. For example, sponsors may have a conflict of interest, so their economic interests in the SPAC may differ from shareholders. Investors should consider these risks carefully. Furthermore, although SPACs are often structured in the same way, each SPAC may have its own unique characteristics, and it is important that investors understand the specific characteristics of any SPAC. is under consideration.
How do SPACs succeed?
Despite these concerns, SPACs are hot. Nearly 300 are in progress this year, with nearly $ 100 billion raised. Why is that? Is it for the benefit of the investors – or for the benefit of someone else?
From an investor’s perspective, SPAC offers access to an experienced management team that seems to be looking for a good company to buy, negotiate favorable terms, and do the business. The management team has every incentive to get it right. He can make a lot of money and, of course, his reputation is on the line. In this sense, it’s like buying into a startup.
Just as a start, however, the team needs to perform – and they need to have a good target market. Here are the two prerequisites for a successful SPAC: a team that can find and find a good company and a good company that is willing to be found.
Will SPACs make sense for companies?
Which brings us to the next question: why would a company want to go the SPAC route, giving that portion to SPAC sponsors, instead of just doing a traditional IPO? Two reasons. First, SPAC is both simpler and more reliable. Instead of trying to sell the company to a large gathering of investors at an uncertain price, there is one agreement for a bargain price. Because of the greater simplicity, this is also a faster process, which can be important. For a company, this is an easier but more expensive way to be public.
Second, the disclosure requirements for SPAC are usually less onerous, and can be attractive for a company that may be at developmental stages. From an investor’s perspective, however, there is just less information available.
So, from a company perspective and a sponsorship perspective, SPAC can make a lot of sense.
A tough game for investors
As an investor, maybe not so much. First, that management team made a bet. Shaq may be a good businessman, but that’s not what he’s particularly known for. Are all the management teams that are building this capital really that special?
Second, they are better off, because of that huge weakening coming from the trustee department. The supporter can (of course, ought to) make up for that deal by adding value in some way. But that is an assumption, not a fact.
Third, many different sponsors and SPACs are currently competing for a limited number of large companies, which have driven up prices and limited the trustee’s ability to add value by negotiating. . Compare this to an IPO, where you know what the company is and have a better idea of the price. This dynamic makes SPACs more dangerous.
Fourth, even among the large companies available, these companies need to publish less information and have more bargaining power than they would in the IPO process. This situation poses risks to the investor.
Ultimately, with SPAC there is an expectation – but not a promise – of an interesting company at a great price. But this has always been a tough game, and it’s getting harder.
These dangers may seem theoretical, but they are real. While recently launched SPACs (pre-target builds) tend to stand up relatively well, studies have shown that postmerger results are disappointing. Renaissance Capital examined the performance of 313 SPO IPOs from 2015 to the end of 2020 and found that SPACs with completed unions delivered an average loss of nearly 10 percent, well below the average yield for traditional IPOs, which had a yield an average of 47 percent over the same period. This number is troubling and certainly not what the hype would mean. In addition, not all SPACs work, with at least one major break.
Look no further than the hype
The hype is great. But at the end of the day, SPACs are just a capital building tool, designed to serve the interests of companies trying to access the public markets and their supporters. They are not designed specifically for investor benefit and exhibit the same risks as a traditional IPO, as well as a number of their own. They are also, at the moment, a marketing tool. Investors should be very aware of that when evaluating their options.
Check out the background of anyone recommending SPAC. Learn about the background, knowledge and financial motivation of SPAC supporters; how the SPAC is structured; the securities offered; the risks associated with investing in the SPAC; plans for business mix; and the rights of other shareholders by carefully reading a guidebook that may be available through the SEC’s EDGAR database. Further, investors should consider the potential costs, risks and benefits of the investment in relation to their own investment objectives, risk tolerance, investment horizons, net worth, investments and assets available. existing, debt, and tax considerations.
Can SPAC be a good investment? For sure. Can it be a bad investment? Yes of course. The point is, it is an investment, just like anything else. Caveat emptor.