The SPAC Phenom — Behind Startups’ Urge To Merge — List It Or Lose It!
Inevitable fallout from SPACulation won’t be without pain.
On March 4, 2021 Fast Money posted this review of SPACs under a provocative title, “SPACs are an inside joke on Wall Street, and the joke is on you” and it had an even gloomier sub header, “SPACs can operate like ‘venture capital in the public markets,’ which may appeal to amateurs seeking their inner Elon Musk. But it rarely works out well for the retail crowd.” Ouch!
A few weeks earlier on Feb 9, 2021 CNBC had headlined a report, “Sam Zell calls SPAC craze largely ‘rampant speculation’ reminiscent of 1990s dot-com bubble,” in which Mr. Zell had used the dreaded B-word — bubble — of financial markets in referring to the SPAC mania that had gripped the U.S. investment community:
“Billionaire investor Sam Zell told CNBC on Tuesday that some deals involving special purpose acquisition companies, or SPACs, remind him of the speculation in internet companies during the 1990s dot-com bubble.”
Is a SPACtacular meltdown in the cards?
In fact, Forbes had already warned of a “looming SPAC meltdown” back in its November 19, 2020 cover story, “How hedge fund traders known as the SPAC Mafia are driving an $80 billion investment boom with a no-lose trade.” Its authors wrote:
“The SPAC boom of 2020 is probably the biggest Wall Street story of the year, but almost no one has noticed the quiet force driving this speculative bubble: a couple dozen obscure hedge funds like Polar Asset Management and Davidson Kempner, known by insiders as the “SPAC Mafia.” It’s an offer they can’t refuse. Some 97 percent of these hedge funds redeem or sell their IPO stock before target mergers are consummated, according to a recent study of 47 SPACs by New York University Law School professor Michael Ohlrogge and Stanford Law professor Michael Klausner.”
The critique went on to deliver some rather grim SPAC-stats:
“According to NYU’s Ohlrogge, six months after a deal is announced, median returns for SPACs amount to a loss of 12.3%. A year after the announcement, most SPACs are down 35%. The returns are likely to get worse as the hundreds of SPACs currently searching for viable merger partners become more desperate.”
Uh-oh! But before we get the equivalent of a 1980s Maaco moment — albeit, concerning a SPACtacular meltdown — let’s review the broader landscape of how we got here. Even though SPACs have been around since the early 1990s, they gained steam only in the past couple years. In its Feb 20, 2021 article, “Why SPACs are Wall Street’s latest craze.” The Economist explains what sparked this fever:
“The latest mania can be traced to a serendipitous deal struck in 2019 by Chamath Palihapitiya, a venture capitalist turned boss of a SPAC, and Sir Richard Branson, a billionaire businessman.
Mr. Palihapitiya’s SPAC had raised $674m, wooing investors with promises of disrupting the IPO scene. Sir Richard had sought funding for Virgin Galactic, a space-venture company, from Saudi Arabia’s sovereign-wealth fund. But after Jamal Khashoggi, a journalist, was killed in a Saudi consulate in Turkey, Sir Richard suspended the plan. A year later Virgin Galactic merged with the SPAC. It received the $674m pot, and another $100m in investment from Mr. Palihapitiya, and went public at a valuation of $2.2bn. Its market capitalization is now $12bn.”
Nonetheless, a rival U.K. publication, The Financial Times, also cautioned investors about SPAC mania, in its Feb 24, 2021 report, “Why London should resist the SPAC craze.” FT was not only concerned about the lack of due diligence but also the insufficient disclosure requirements that SPACs seemed to enjoy:
“One fundamental selling point is also an intractable problem: SPACs exist in part to skirt the normal IPO disclosure requirements that are themselves designed to protect investors’ interests.”
Here a SPAC, there a SPAC, everywhere a SPAC…
Yet SPACs have taken off like a rocket ship, way faster than the Virgin Galactic space-venture company that Mr. Palihapitiya’s afore-mentioned SPAC funded. In a March 3, 2021 report, “SPACs are now a $700 billion market,” Yahoo Finance revealed that in just a couple of months in 2021 SPAC sponsors have nearly outpaced all of 2020:
“Through February 26, some 175 SPAC sponsors have debuted on the public market raising a total of $56 billion. In all of 2020 — a record year for SPAC IPOs — some 223 SPAC sponsors came to market.”
So, SPACs have been proliferating like weed stocks (pun intended) have due to the increasing deregulation of pot in the past few years. An author/analyst in the world of high finance, Mr. Andrew Ross Sorkin (co-anchor of CNBC’s Squawk Box, author of “Too Big to Fail” and co-creator of the Showtime drama series Billions) joked about this in his February 10, 2021 DealBook story, “Wall Street’s New Favorite Deal Trend Has Issues” in the New York Times. He wrote:
“‘I know more people who have a SPAC than have Covid,’ several financiers have told me recently.”
But on a more serious note, Mr. Sorkin explained the critical difference between a SPAC and the conventional IPO, as follows:
“When a company goes public through the traditional I.P.O. process, it must show potential investors its prior financial records. It is not allowed to make projections about its earnings, because regulators have long worried that companies could mislead investors with unrealistic forecasts.
In a SPAC transaction, which is a merger instead of a listing, companies can publish their financial projections, many of which will prove to be inflated. Since many companies merging with SPACs have no earnings, this has become a useful feature.”
“King of SPAC” roots for the common man.
Mr. Sorkin went to explain how SPAC sponsors and name-brand investors make out just fine but it’s the post-merger public investors that are likely to get burned. This aspect of helping the small guy, i.e., the retail investor, was the subject of much discussion after the recent Reddit/Robinhood raid on Wall Street. During the initial weeks of the ongoing GameStop (ticker symbol: GME) trade {sidebar: while its momentum appears to have subsided, nevertheless it persists on a smaller scale even in a down market, given that GME is still a triple digit stock — closing at $132.35 on March 4, 2021 — almost two months after the start of that infamous short squeeze}, the aforementioned SPAC king, Mr. Palihapitiya, went on CNBC’s Fast Money Halftime show on January 27, 2021 to defend the Reddit/Robinhood retail investor. Per a CNBC report, “Chamath Palihapitiya closes GameStop position, but defends investors’ right to sway stocks like pros,” he said:
“Instead of having ‘idea dinners’ or quiet whispered conversations amongst hedge funds in the Hamptons these kids have the courage to do it transparently in a forum,” he said. “What it proves is this retail [investor] phenomenon is here to stay. There are 2.7 million people inside wallstreetbets. I think they are as important as any hedge or collection of hedge funds.”
SPACulation and the average Joe.
This anti-hedge fund act, coming from the master of the SPAC universe, appeared a bit rich. In fact, I had tweeted my surprise on January 27, 2021 as reproduced below:
It’s well-known that a lot of SPAC funding is dominated by venture capitalists and hedge funds who also seek to diversify their investment strategies beyond their traditional IPO space. It’s not that they don’t understand that startups are increasingly relying on easier access to capital by simply merging with adequately funded SPACs. What remains to be determined is whether these post-merger SPACs are also providing retail investors a better opportunity at gains than traditional IPOs have in the past? So far, SPACs have largely simplified access to capital for startups and companies generally, but public investors are still left wondering Jerry Maguire style, “show me the money.”
Notwithstanding all the chest thumping that is going on with SPAC-palooza, the more things appear to change, the more they have remained the same for the average Joe investor. It will probably take another nearly decade-long investment frenzy — à la, the 1980’s junk bond-financed leveraged buyout (LBO) mania, or the 1990’s venture capital-financed dot com bubble, or the 2000’s subprime mortgage-financed real estate hysteria — to burst the 2020’s SPAC-financed direct listing bubble. As with all of our previous financial passions, the fallout from SPACulation won’t be without pain — to be forewarned is to be forearmed!
