At the close of 2020, many market commentators dubbed the year gone by not only the year of coronavirus, but the year of the SPAC (Special Purpose Acquisition Company).
Indeed, the number of SPAC IPOs launched in 2020 increased over 400% from the year prior, while gross proceeds from these deals soared over 600%. Not surprisingly, many economists, academics and investment managers have voiced concerns that the surge in popularity of SPACs is a sign of the “irrational exuberance” that often precedes a market bubble’s burst.
Their warnings appear to have gone unheeded so far in 2021.
SPACs have already raised more in just the first three months of the year than they did in all of 2020. As of mid-March, a staggering $76.7 billion had already been raised by 264 of them, according to Renaissance Capital, with a host of celebrities such as Alex Rodriguez, Shaquille O’Neal and Serena Williams following marquee investors Bill Ackman and Chamath Palahapitiya into the craze.
As Natalie Hwang, founding managing partner of VC firm Apeira Capital, said, the running, albeit tasteless, joke going around in some investment circles today is “I know more people who own SPACs than have gotten COVID.”
Given the still-growing popularity and FOMO felt by many investors amidst the craze, the question of whether SPACs really represent a dangerous bubble or simply a misunderstood and unfairly maligned new investment opportunity is worth examining further.
What’s Pushing the Popularity?
Of course, the SPAC trend is not emerging from out of nowhere. Rather, to many, they are an innovative and advantageous way to go public during the COVID-19 pandemic, which has left many firms unwilling or unable to pursue traditional IPOs.
“COVID created a major craze about SPACs because companies simply could not go public,” said Jonathan Mitchell, Head of B. Riley Securities’ SPAC Banking practice. “An industrial company, for example, could not get a proper valuation based upon numbers they would’ve been reporting [through the traditional IPO process].”
Mitchell and others also noted that SPACs can aid in democratizing access to so-called “unicorns,'' allowing investors earlier access to these companies that was previously reserved for institutional investors, and giving public market investors a right to sell in the open market at any time during the process or redeem at the IPO price plus interest.
“The late stage VCs often would make 50% or 100% or more on an investment they make a year or so before an IPO at a steep discount to the price the public will get,” said Ahmed Fattouh, CEO of InterPrivate Acquisition Corp., a SPAC that recently completed a merger with lidar firm Aeva. “The SPAC eliminates much of that discount with the benefit being shared by the Company, the SPAC investors and the sponsor themselves.”
Victims of Their Own Success?
Yet, the issue for SPACs may in fact be driven by the very popularity the companies are currently enjoying.
Recent research published in the Harvard Business Review pointed to reverse mergers as a possible precedent for the path still ahead of SPACs. The article, authored by INSEAD professor Ivana Naumovska, noted that the confluence of SPACs’ popularity with increasingly bad publicity and regulatory scrutiny matches up nearly perfectly with the trend seen in reverse mergers, in which the average share prices of firms that entered into reverse mergers had dropped by nearly half only a few years after their popularity had peaked.
Overall, Naumovska suggests that SPACs are a bubble that will burst as an influx of low-quality players, coupled with bad PR and increased SEC oversight, ultimately over-inflates and pops the ballooning industry.
Dr. Robert R. Johnson, a professor of finance at Creighton University was inclined to agree, voicing his scorn for the SPACs, as well as other trendy new investments, more coarsely.
“The late American comedian Robin Williams was quoted as saying ‘Cocaine is God’s way of saying you’re making too much money’,” Johnson said. “With the introduction of Special Purpose Acquisition Companies and Non-fungible Tokens, it appears that God has found a new way to deliver that message.”
Yet, it is not just academics offering a pessimistic outlook on the trendy investment. Indeed, a growing number of investors are betting on the bubble’s imminent burst.
According to financial data analysis firm S3 Partners, short interest in SPACs has jumped over 300% since last year, signaling a broader belief that many SPACs may have gotten ahead of themselves.
Proceed...But with Caution
As of yet, despite the growing crowd of investors betting against them, pronouncements about a catastrophic bubble burst have thus far been premature.
Still, even those with more moderate or even bullish views on SPACs would advise one to tread carefully and do the requisite research, especially given the trend toward adverse selection apparent as issuance reaches a fever pitch and the likelihood that traditional IPOs see a renaissance as the economy slowly re-opens.
“Investors should always do their homework and not get caught-up in the hype or fad of any particular financial product. I think the same applies for SPACs,” said Reena Aggarwal, the director of the Center for Financial Markets and Policy at Georgetown University. “There will be winners and there will be losers. Many SPACs have strong management teams and business models, and then there are those that seem more speculative and are taking advantage of the current risk-appetite in the market.”
Apeira Capital’s Hwang noted that “as we track the performance of SPACs over time, that will potentially start to shift sentiment, and that creates some degree of market rationalization.” Hwang said she expected this rationalization to happen in the next two to three years.
B. Riley Securities’ Mitchell stressed the divide in SPACs between “winners” with the requisite investment acumen in the boardroom, and the likely “losers” promoted by celebrities or those otherwise possessing little investment experience, that likely lays ahead. He urged retail investors to do their due diligence on SPACs, as they are not all created equal.
“Retail investors should study every investment before they invest and avoid investments that they just don’t understand,” he concluded. “You shouldn’t just jump on the bandwagon because someone popular is promoting them.”