- Popularity of Special Purpose Acquisition Companies increased during the pandemic
- In the US, SPACs raised $82 billion in 2020, accounting for more than half of all IPO funding
- Particularly popular with telecoms and IT companies
- But "poor man's private equity funds" risky for small private investors
It's springtime. The birds are singing, the buds are bursting, newts are mating and you can't move without tripping over a SPAC. Special Purpose Acquisition Companies are very much investment vehicles de nos jours and are particularly attractive to some telecoms and IT companies operating in strategic niche markets. Theses entities, also also known as "blank check companies'' (or 'cheque' in the UK), are shell corporations which are listed on a stock exchange, their purpose being to acquire private companies and making them quickly public without going through all the fuss, bother and compliance of prepping for a traditional initial public offering (IPO). What could possibly go wrong? Not much provided investors remember that the value of a fashionable trend can go down as well as go up.
So hectic is this market that the frenzied activity it is now routinely referred to as "SPAC Mania". Interest in the vehicles has boomed since the outbreak of the global Covid-19 pandemic and 2021 seems set to be the most active SPAC year yet. Last year, SPACs raised a massive US$82 billion and accounted for more than 50 per cent of total IPO funding. They gathered-in more hard cash than they did throughout the entirety of the preceding decade. However, that market exuberance has not necessarily translated into unalloyed good news for investors. Research undertaken by Stanford and New York Universities analysed 47 SPACs that were merged between 2010 and 2020 and found that they tended to lose an average of 33 per cent of value once the merger had been completed - although there were also examples of winners producing some very positive returns.
The US Securities and Exchange Commission (SEC) defines a SPAC as a vehicle "created specifically to pool funds in order to finance a merger or acquisition opportunity within a set timeframe. The opportunity usually has yet to be identified". Because a SPAC is registered with the SEC and a publicly traded company, the general public can buy shares before the merger or acquisition takes place, that's why they are often disparagingly referred to as "poor man's private equity funds." Research by other US academic institutions has shown that investor returns on SPACs post-merger are "generally negative" and their popularity coincides with the frothiness of periodic economic bubbles. SPACs are also associated with high promotional, management and underwriting fees.
The capabilities and reputations of management teams is particularly important where SPACs are concerned because, of course, there are no previous operations or financial data to access. Once funds have been raised they are kept in trust until either the management team of a SPC identify a company of interest to acquire and merge with, or, if no such company of interest has been found or the SPAC fails to merge with one before a given deadline date (usually two years) the SPAC is liquidated and investors get their money back, minus a few incidentals, natch, given that investors provide capital without having any prior knowledge of how the funds they provide will actually be used.
Given the uncertainties and complexity surrounding the traditional IPO route, SPACs are proving attractive to a variety of telecoms and IT companies, start-ups and established enterprises alike. For a target company the process is faster, cheaper and considerably less intrusive than the traditional floatation route as there are far fewer disclosure requirements. Such reverse merger listings have gained popularity as they emerge as cheaper and faster alternatives to traditional IPOs.
Refinitiv, a subsidiary of the London Stock Exchange Group and global provider of financial market data, says 25 telecoms and IT companies took advantage of combining with SPAC vehicles to list on the US exchanges over the course of 2020 (it is a very much more difficult and convoluted to do the same in the UK). The US listings accounted for an equity value of $15.3 billion. In 2021 one of the most recent examples is Airspan Networks which is merging with a SPAC to fund an initiative to provide infrastructure to US 5G network operators as they rip-out Huawei equipment. Another is Kore, the Atlanta, Georgia-based IoT company that is merging with the specialist SPAC, the Cerberus Telecom Acquisition Corp.
A comparative analysis of the lifecycle of the newt and the SPAC
Like newts, SPACs have a life-cycle. In P.G. Wodehouse's "Jeeves and Wooster" comic novels Gussie Fink-Nottle's explanation of the lifecycle of the salamandridae is simplicity itself and runs thus; "Do you know how a male newt proposes, Bertie? He just stands in front of the female newt vibrating his tail and bending his body in a semicircle. I could do that standing on my head." Bertie Wooster responds, "Well all right, if they like it. But it's not my idea of molten passion." Simple. eh? However, the life-cycle of a SPAC is rather more complex and rather less amusing.
Chicago, Illinois-headquartered RiverNorth Capital Management that has $4.9 billion in assets under management and has published a guide to the four-stage lifecycle of the SPAC, each one of which has its own risk/return profile and opportunity.
Stage 1, "The IPO", money is raised for the SPAC and investors buy into it based on their view of the quality of the SPAC’s management team and the terms offered The units are priced according to anticipated demand and other prevailing market sentiments and when sold the amount raised is placed in a trust account. This stage is characterised as "low risk.
2. The "Seeking Stage". Here shares can trade above or below the IPO price. Units can be separated into common shares and warrants and either can be traded. If an acquisition target is not found within a limited time period, usually 18 or 24 months, the SPAC will liquidate and return the trust account value to common shareholders while warrants will be worth nothing. A tad risky then?
3. The "Post Announcement" Stage. At this point the share price is now at least partially based on the market’s determination of the value of the acquisition target. In theory there is no limit to how high the share price can go, but any downside remains limited because investors have the right to redeem their common shares for the value in the trust account. In the case of an attractive acquisition the common shares could trade up a lot, but even for a perceivedly bad acquisition they may not trade all that far below the original unit price. However, warrants could trade close to zero according to market sentiment. Naturally enough, shareholders will vote for the acquisition but they also have the right to redeem their common shares. However, should the majority of shareholders do that there won't be enough cash left in the trust account for the acquisition to be completed.
4. The "Post De-SPACing" Stage. At this stage the stock is no longer a SPAC and, just like any other public company, will trade on the Stock Exchange at market value sentiment determination. Shareholders no longer have the redemption option and shares could trade all the way down to a value of zero. This is far and away the riskiest stage of the SPAC life cycle. Meanwhile, for the newt the main, and terminal danger is being eaten by foxes, snakes and birds such as herons and buzzards.
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