What the Hack is SPAC?
During 2020, we started hearing a lot about the new kid on the block in US capital markets -- SPAC, abbreviation for special purpose acquisition companies. I recently started seeing SPAC marked as a potential exit strategy in some investment documents and was wondering if it would be a good idea to look deeper into this instrument and how it can evolve. In this article, we shall look at the history of SPAC, how it evolved until the boom in 2020, and what are the main benefits and risks of using this financial vehicle. In our next article, we shall address more technical issues on what the mechanics of SPAC look like and how money flows through it.
What is SPAC actually?
As mentioned, the SPAC IPO is short for Special Purpose Acquisition Company and it might be seen as alternative to the traditional IPO by listing companies in exchanges. In essence, this 'blanco' check financed shell company formed with specific purposes such as a merger, share exchange, asset acquisition, share purchase, reorganization, and similar transactions with one or more businesses within a defined time framework, which is usually 12 to 24 months.
The SPAC is founded or formed by the sponsors that jointly own the blank check vehicle. With a specific transaction in target or industry focus, the SPAC is a publicly traded shell where institutional investors or retail investors can obtain part or a unit of SPAC. It is later converted into a target company and in our next article we shall write more about the mechanics itself.
History of SPAC Market
I was wondering if SPAC is really the new kid on the block and then I remembered Onnix IPO and Kimmes-Wright funds from the ‘80s and huge fraud scandals. So the short answer would be no, SPACs are not completely new.
After the ‘90s and huge surges in filing of SPACs due to fraudulent activities, they faded away. In 2003, they had another strong run, while in 2007 there were 66 SPAC IPOs that raised $12.1B. The global financial crisis of 2008 shut down the risky SPAC market once again.
However, in 2010 with new changes to the rule book, SPACs have made a comeback and have been trending upward in use. In 2019, 59 SPAC IPOs raised a total of $13.6B. But 2020 gave it a boost and the SPAC market came back stronger than ever. Only in October 2020, there were 125 SPAC IPOs in total of $47.5B.
Let's take the look at some numbers courtesy of CB Insights and Deloitte US.
Picture 1. CB Insights SPAC IPOs overview shows how they have spiked in 2020 (full report available at CB Insights)
Picture 2. SPACs per Industry by Deloitte (full report available on their site, source Intelligize)
Key to SPAC success
For SPAC to be successful, it would be instrumental to have strong sponsors. Sponsors can make up to 20% of the acquisition target at very little cost and they are motivated to promote SPACs. But looking at credibility, management team, and track record of the sponsor, it might be a crucial thing for writing a blank check to someone, as an investor is technically looking into no operating cash flow shells. Needless to say, its assets are more intangible in nature than tangible.
On the other side, the SPAC offers many benefits including access to liquidity with less hassle than the traditional IPO.
SPAC risks to pay attention to
We already mentioned sponsors and management team as instrumental for SPAC success. However, although the wave was started by financial professionals and PE sponsors that know their way around the M&A market, we have seen an increase in sponsors coming from other realms such as politics, sports and even the entertainment industry leveraging their visibility and celebrity status. Needless to say, that caution must be exercised when assessing SPAC investments
As significant funds flew into SPACs in 2020, we are most likely looking at a very active M&A period over the next 2 years (remember SPAC's have an expiration date set up to 24 months from IPO closing). This might lead to unrealistic high valuations as mergers might be born out of urgency and not prudency or profitability. These high valuations might subsequently lead to the lower post-merger returns than expected. In addition, the bounce back of valuations in the IPO market might affect availability of highly desirable targets of SPAC professionals.
If post merger returns are weaker than promoted, we might see additional pressure on the SPAC market and slowing down in the upcoming years.
Conclusion
Despite all the risks, SPAC is an interesting instrument and can bring desired liquidity that is much needed in the current market. We believe that SPAC has its space in the market and will generate healthy returns to many investors and sponsors. Hopefully, SPAC will position itself where it adds the most value and might be instrumental in helping companies grow for truly optimal IPO listings and returns.
We have heard very good arguments why someone should target the SPAC market and how new changes in direct listings might take a part of the sunshine from the SPACs. If you want to check out the latest changes on primary direct listings, please visit the SEC site.
We shall look a bit deeper into SPAC mechanics in our next article, stay tuned!
Please note that this is not investment advice or investment suggestion. We suggest you do a deep and proper due diligence, and research in case you are interested in investing in the SPAC market or accessing the SPAC market as issuer. If you have any questions please be so kind to contact us directly either via LinkedIn or via email at [email protected].