There was a record volume of special purpose acquisition company (SPAC) initial public offerings (IPOs) in the first quarter of 2021, but questions remain about the sustainability of the trend.
The record volume was most likely a result of the stock market surge over the last 12 months or so—many private companies were looking to access the public markets quickly. However, the SPAC growth slowed in April, at least in part due to the SEC. SPAC IPOs totaled almost 300 in the first quarter but fell to 10 in April (data from SPAC Research via CNBC). Where SPACs end up in the hierarchy of equity issuance is still unclear.
What’s a SPAC?
The SPAC, also known as a “blank check company,” was created almost 30 years ago, in 1993, as an alternative form of an IPO. SPACs are shell firms that list on a stock exchange for the purpose of combining with a private company to take it public.
A few SPAC features:
- They have no “actual operations” and are created solely to raise capital for the existing firm;
- The SPAC generally issues shares at $10;
- The manager of a SPAC has two years to make an acquisition or must return money to the investors;
- The acquisition isn’t disclosed before the SPAC becomes publicly traded;
- Once the acquisition is announced, the SPAC merges with the private company;
- The SPAC investor then becomes a shareholder of the acquired company.
SPACs are really a shortcut both in time and money to taking a private company public, which as mentioned, was the most likely driver of the increase in issuance. A key differentiator from the traditional process is that fewer disclosures are required, and less time and money are spent making these disclosures. Because of this, the SEC started taking an interest as SPACs gained popularity. The SEC recently issued a public statement on how warrants (the right to purchase shares at a preset price) in many cases should be classified as liabilities, not equity. This change could dramatically alter the quality of a company’s balance sheet and is believed to be a factor in the decline of SPAC issuance.
The SEC made a more impactful statement in April, warning companies going public through SPACs against making unrealistic projections: SEC.gov | SPACs, IPOs and Liability Risk under the Securities Laws. For example, WeWork, the coworking-space company, is now trying to go public through a deal with the SPAC BowX. It’s important to recall that WeWork famously failed in a traditional IPO in 2019. While hyping the company to investors, BowX’s chairman called WeWork a $5 billion revenue company. But, rather importantly, that number represented a projection and not the firm’s actual revenue. WeWork’s traditional IPO failed when disclosures revealed conflicts of interest within the company and the level of losses it was experiencing. If this second attempt at the public markets through a SPAC is an attempt to avoid those disclosures, WeWork/BowX investors could suffer economic harm.
There’s an appeal to SPACs. An investor purchasing a SPAC before the target acquisition is announced is betting the market will react positively to the announcement. The value could rise even more if the newly acquired company performs well. The investor has gained access to the investment much earlier than after a traditional IPO. In a traditional IPO, the investor is essentially coming in after the target announcement, missing one chance for appreciation. Given that IPOs can pop before shares truly hit the open market, another opportunity for appreciation is removed.
The long-term prospect for SPACs remains unknown. SPACs are a riskier investment than traditional IPOs for a couple of reasons. At the outset, the investor doesn’t know the acquisition target. But even once the target is known, the limited disclosures can prevent a complete analysis. There’s a reason that a SPAC is also called a “blank check company.” An investor is giving someone a blank check and hoping for the best. The SPAC sponsor must identify the target company, complete the acquisition, and transition to a successful, publicly held operating business. A misstep at any point in the process can significantly diminish investment value.
Ben Connard is a partner and portfolio manager at Eagle Ridge Investment Management LLC, www.eagleridgeinvestment.com