Some Thoughts About SPACS

SPACs (special purpose acquisition companies) have become the rage of late.  It stands to reason that SPACs, or something like them, would become popular. Familiar and traditional equity investments have gained so much for such a long time now that investors naturally are searching for investments that they can believe offer a bargain.  Nonetheless, they should exercise care. Though SPACs are a perfectly legitimate investment vehicle, on average they do not have an especially good performance record.  Also of concern is the light regulation applied to them, which shortchanges prospective investors of the kinds of disclosures they can receive about other investment options.  Unless the specifics of a particular SPAC investment are clear, most investors should avoid them.

SPACs are nothing new; they have been around for more than quarter of a century.  Each SPAC begins life as a shell company with no operating activity.  Via an initial public offering (IPO), it lists itself on a public equity exchange, selling stock to investors on the promise that within a certain time frame it will find a private firm with which to merge and thereby create an operating, publicly traded, company that presumably will rise in value.  The rules governing SPACs dictate they must dedicate at least 80 percent of the capital they raise to acquire the target company, nor can a SPAC identify a target while it is raising the equity capital, hence their nickname – “blank check companies.” 

The recent surge is impressive.  SPACs sold more than a record $100 billion in stock in the three and a half months through mid-April.  Transactions with SPACs and conventional IPOs approached some $250 billion in this same period – about as much as in all of 2020.  Aside from bargain-hunting, the appeal, both to investors and the private firms they target for merger, is that SPACs can make an end-run around the expensive and burdensome procedures associated with more conventional IPOs.  But therein lurks the risk for the investor.  For one thing, SPAC managers, because they must make their acquisition within a certain defined time, may overpay – hardly appealing to a bargain hunter.  Because SPAC mergers avoid many of the disclosures and explanations required of a more conventional IPO, investors have less information on which to make a judgment.  As well, SPAC managements often muddy things further by hyping the earnings potential of the companies they bring public, a tactic forbidden to conventional IPOs.  

Some media have compared today’s SPAC activity to the dot-com boom of the late 1990s, when many heavily indebted and profitless companies, armed only with an idea, hopes, and clicks, attracted huge amounts of investment dollars as they willy-nilly listed themselves on exchanges.  Though there is a superficial resemblance, on a relative basis today’s SPAC surge is nowhere near as large as was the dot-com craze.  But in another respect, SPAC activity today is the reverse of the dot-com boom.  With the latter, investors’ equity capital was often used to buy into a heavily indebted firm.  With SPACs, because the mergers they engineer often require the target to pay down debt, the process is eliminating debt, especially junk bond debt.  Indeed, the buybacks of bonds have reached the point where they are actually pushing up the price of many junk bonds. It is noteworthy here that, so far in 2021, the volume of new firms listed on the stock market dwarfs the $180 billion in new junk bond issues.  Unlike the dot-com era, when equity sales enabled indebtedness, today the equity sales are relieving it.  

Though the debt relief helps the stability of financial markets, the Securities and Exchange Commission (SEC) has nonetheless turned its gimlet eye on SPACs,  and that development suddenly and dramatically curtailed SPAC activity late in April.  Typically, the SEC remains closed-mouthed about its concerns or plans, but it is likely that it has focused, in part, on the relatively light regulation of SPACs and the resulting lack of transparency.  Though there is no rumor of illegality, people outside the Commission have mentioned as a possible SEC focus the SPAC practice of treating warrants –– the sale of a right to buy stock at a certain price by some time in the future (and a key way that SPACs raise money) –– as an asset.  If the authorities were to move on either transparency or on warrants, it would all but erase the appeal of SPACs in bringing private firms public.  In the meantime, all the risks outlined here remain for the average investor.         

One thought on “Some Thoughts About SPACS

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s