By SJS Investment Services Chief Investment Officer Tom Kelly, CFA.
“What do you mean I don’t have any more money in my bank account? I have all these blank checks!”
I was reminded of this oft-quoted family teaching moment on the value of a blank check (the speaker of which will remain anonymous) when I first heard about SPACs. Special-purpose acquisition companies (SPACs), sometimes referred to as “blank check” companies, offer an alternative to the traditional Initial Public Offering (IPO) process of taking a company from private to public. A SPAC is a publicly traded company that raises money from investors with the intent of taking some not-yet-determined private company public. Like giving your child a blank check to go buy whatever they want. What could go wrong?
A SPAC is created by a sponsor (often of celebrity status) which issues publicly tradeable shares (typically $10 per share) in exchange for investor money. Once enough money is raised, the sponsor searches for a target company to acquire. The investors often have little idea what company will be acquired, or even if there is a targeted industry. After the SPAC finds a private company and completes a SPAC IPO, then the shares of the SPAC merge into the shares of the new publicly traded company. For their efforts, the sponsor typically receives 20% of the new publicly traded company’s post-SPAC IPO common shares (known as the promote). However, if a SPAC IPO is not completed within two years, then usually the SPAC is liquidated and investors get their money back.
SPACs are not new, but they have received notoriety as of late. There were 248 SPAC IPOs in 2020 raising $83 billion, and 288 deals with over $93 billion in proceeds so far in 2021 (through March 23). In contrast, there were 226 SPAC IPOs raising $47 billion total from 2009-2019.[1]
Compared to traditional IPOs, the potential benefits of SPAC IPOs include:
For the private company, a typically faster public listing from the merger announcement to completion.
For the private company, usually greater certainty regarding IPO money raised.
For investors, purported access to private companies which the average investor would not typically have access to.
On the flip side, investors do not know what the investment will be, so there is a high opportunity cost in waiting for a deal to be announced since the invested funds are typically sitting in an escrow account. Sponsors are incentivized to do a deal to receive the promote, even when private companies are expensive.
So, does giving a sponsor a blank check pay off? While there is a wide dispersion of results and a relatively limited dataset, the results are not pretty. From 2019 through early 2020, SPACs had both negative average and median returns in the 3-month, 6-month, and 1-year periods following the completion of a merger; SPACs had worse returns than both the Renaissance IPO Index and Russell 2000 Small Cap Index over all respective periods.[2]
Source: “A Sober Look at SPACs“. Michael Klausner, Michael Ohlrogge, & Emily Ruan, 16-Nov-2020, ssrn.com. Avantis Investors. Data reflects the 2019-2020 merger cohort. Of the 47 SPACs examined, 47 had sufficient history for the three-month period, 38 for the six-month period and 16 for the 12-month period. The IPO Index is the Renaissance IPO Index. The Small Cap Index is the Russell 2000 Index. See Important Disclosure Information.[2]
On the other hand, the SPAC sponsors - which receive the promote - have been rewarded handsomely, with an average 1-year return of 187% and median 1-year return of 32% for sponsors.[2] SPACs appear to be a much better “investment” for sponsors rather than the investors. In an effort to highlight potential risks for investors, the SEC has done the following:
December 2020: Issued guidance regarding SPACs, identifying potential conflicts of interest and disclosure concerns related to SPAC IPOs and subsequent transactions.[3]
March 2021: Issued an Investor Alert that states, “Never invest in a SPAC based solely on a celebrity’s involvement or based solely on other information you receive through social media, investment newsletters, online advertisements, email, investment research websites, internet chat rooms, direct mail, newspapers, magazines, television, or radio.“[4]
March 2021: Has opened an inquiry into SPACs and is seeking information on how underwriters are managing the risks involved.[5]
Investor beware.
So before investing in the next hot SPAC deal, it may be wise to reconsider who you are giving your blank check to. We think that most investors would instead be better off over the long-term using a science-based, low-cost, broadly-diversified investing strategy such as MarketPlus Investing®.
If you have any questions about SPACs or your investments, please reach out to us. We are happy to listen and assist.
Important Disclosure Information And Sources:
[1] “SPAC Statistics“. SPACInsider, 23-Mar-2021, spacinsider.com.
[2] “A Sober Look at SPACs“. Michael Klausner, Michael Ohlrogge, & Emily Ruan, 16-Nov-2020, ssrn.com. The Renaissance IPO Index® (IPOUSA) is a stock market index based upon a portfolio of U.S.-listed newly public companies that includes securities prior to their inclusion in core U.S. equity portfolios. The Russell 2000 Index measures the performance of the 2,000 smaller companies that are included in the Russell 3000 Index, which itself is made up of nearly all U.S. stocks.
[3] “Special Purpose Acquisition Companies: CF Disclosure Guidance: Topic No. 11“. U.S. Securities and Exchange Commission, 22-Dec-2020, sec.gov.
[4] “Celebrity Involvement with SPACs – Investor Alert“. U.S. Securities and Exchange Commission, 10-Mar-2021, sec.gov.
[5] “U.S. regulator opens inquiry into Wall Street's blank check IPO frenzy“. Jody Godoy & Chris Prentice, 24-Mar-2021, reuters.com.
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