Roaring 20s for SPACs?
Special purpose acquisition companies (SPACs) have dominated M&A activity this year. Is this meeting of minds between technology and finance a pandemic-driven fad or the wave of the future?
Even for a ‘super-app,’ the announcement was astounding, sending shockwaves through global markets. On April 13, Grab, a Singapore-based tech powerhouse that started as a ride-hailing app and has since branched out into banking, hospitality, insurance and other services, announced that it would join the latest Wall Street frenzy, going public on Nasdaq via a $39.6bn merger with Altimeter Growth Corporation, a SPAC. The merger has been the biggest M&A deal globally in 2021.
SPAC is the acronym of the year in finance. Also known as blank-cheque companies, a term many SPAC aficionados reject, these idiosyncratic shell corporations have been around for almost two decades. But it’s only over the last 18 months that they have finally found their way into the mainstream. A typical SPAC lists on the stock market with the explicit aim of acquiring a private company that wishes to go public. Targets tend to be tech firms with high-flying ambitions, such as electric vehicle makers and space transportation companies.
Even if the bulk of SPAC activity is concentrated in the US, their appeal is universal enough to attract Asian unicorns such as Grab, says Alexandre Lazarow, a venture capital investor and author of a book on emerging start-up ecosystems: “For the very best start-ups, partnering with a SPAC means partnering with experienced operators, investors and venture capitalists who offer a friendly, globally connected and founder-centric capital source that will be hugely beneficial in expanding their business.”
Boom and bust
Financial markets have welcomed the SPAC boom with relief, as one the few success stories of the year, with the global economy still reeling from the pandemic. The Ipox SPAC Index, which tracks the US market, almost doubled its value from its launch last summer to January 2021, although it has since lost some of its gains. By the end of May, 313 SPACs had gone public in the US, compared to 248 last year and just 225 in the previous decade (see Fig 1).
The trend drove global M&A activity to a staggering $1.3trn in the first quarter of 2021, a four-decade record, according to Refinitiv data. One reason for the unprecedented appetite for SPACs is massive liquidity in global markets. With historically low interest rates and aggressive monetary policy by governments and central banks to mitigate the impact of lockdowns, investors have been left with few options other than seeking lucrative, even if risky, deals. For those eager to take a bet on ambitious start-ups, raising debt has never been easier.
Some see in SPACs the latest example of a broader movement away from the old-fashioned IPO, foreshadowed by the increasing number of direct listings. In the first quarter of the year, SPACs accounted for 75 percent of US listings compared to just 25 percent for IPOs, whereas five years ago they accounted for a tiny 10 percent. Some point to the sheer convenience of swapping a legally burdensome IPO for a merger with a public company.
Companies that list on the stock market via a SPAC merger can save up to 15 months. In tech circles, IPOs are seen as costly compared to other options. “There is the perception that with an IPO you may leave money on the table, for example when the price goes up 25 percent in a single day. So people think that SPACs or direct listings provide an alternative,” says Scott Denne, an analyst at 451 Research, part of S&P Global Market Intelligence.
The pandemic has accelerated this process, with travel restrictions rendering road shows obsolete, says Daniele D’Alvia, CEO of London-based SPACs Consultancy and author of a forthcoming book on SPACs. “We live in the Zoom era. Roadshows don’t make sense anymore. In the past, if a Malaysian company wanted to go public, investment bankers supporting the deal would fly to Malaysia to check everything, from the company’s financials to its buildings. Now they cannot do that because of travel restrictions.”
Changes in regulation may have played a role too. Last year, the US Securities Exchange Commission (SEC) modified the criteria for accredited investors to include those with more than $5m in assets.
The change has allowed smaller fish to participate in PIPE investment, the financing mechanism through which SPACs raise capital, hitherto reserved for institutional investors. Although a typical SPAC raises money when it goes public, it often needs investors to cough up extra capital to complete an acquisition. PIPE investors also add their gravitas to the status and valuation of the target company. Grab received $4.5bn for its merger, of which $4bn was in PIPE investment from BlackRock, Morgan Stanley’s Counterpoint Global fund, sovereign wealth funds such as Singapore’s Temasek and Malaysia’s Permodalan Nasional Berhad and several other institutional investors.
‘Sponsors,’ the financiers who launch SPACs and then chase promising companies, are the main driver of the market. They tend to be prominent tech investors and dealmakers such as Ian Osborne, a British pioneer of SPACs who has invested in European tech powerhouses Spotify and TransferWise (currently Wise). “Sponsors make huge returns on SPACs on average, so the supply will be there if there is enough demand,” says Jay Ritter, an expert on IPOs who teaches at the University of Florida. Once a merger – a process known as de-SPAC – has been completed, sponsors typically take up to a quarter of the merged company’s equity, and thus have a strong incentive to close deals.
For tech firms looking for a quick buck, merging with a SPAC can be hugely lucrative
For target companies, identifying sponsors with a long-term plan is a boon. In the case of Grab, one reason for the partnership with Altimeter Capital was the latter’s long-term commitment to the company, Lazarow says, evidenced by the fact that they locked up their shares for three years and led the PIPE process. For tech firms looking for a quick buck, merging with a SPAC can be hugely lucrative. In 2021, the average tech firm that merged with a SPAC received nearly 13 times its revenue, according to 451 Research. The prospect of tapping into public markets is irresistible, says 451 Research’s Denne: “The opportunity to raise money on the public market, while using the same numbers and language you would use to raise money from venture capital firms, appeals to many tech companies.”
Not your usual bubble
In a market where ballooning debt, zombie companies and all-too-generous central banks reign supreme, the fear of a bubble that is just about to burst never goes away. Many worry that the SPAC frenzy will give way to a stampede for the exit, once the tide of free money goes out and those swimming naked are exposed. By April, the proceeds of SPAC listings in the US had surpassed the $100bn threshold, nearly 10 times more than the amount raised in 2019, but the market has significantly slowed down since its first-quarter peak.
One reason for the unprecedented appetite for SPACs is massive liquidity in global markets
One reason is that institutional investors are increasingly reluctant about the market’s prospects, overwhelmed by the sheer numbers of SPACs. Out of 966 SPACs that have been launched since 2003, less than half had announced or completed an acquisition by the first half of the year, while 90 had been liquidated. Sponsors typically have two years to find a target, otherwise they have to return the raised funds to investors. Some think that the market has run out of target companies with a reliable business plan. PIPE investment is drying up, with banks reducing lending to hedge funds that invest in SPACs. Short-sellers are also zeroing in on the market, increasing their bets against SPACs.
Their stock market performance has also been lacklustre. By May, around two out of three SPACs were trading below the $10 threshold, a significant drop from the first quarter when they typically offered a premium to investors. The picture is similar for most SPACs that have found a target. A case in point is Canoo, a US electric vehicle manufacturer whose share price halved just a few months after its listing on Nasdaq last December. Academics Michael Klausner, Michael Ohlrogge and Emily Ryan estimate that although SPACs raise $10 per share in their IPOs, by the time of the merger they hold just $6.67 for each outstanding share, while shares lose around a third of their value a year after the merger (see Fig 2).
Critics mock the lofty projections made by companies that merge SPACs. Some have never run a profit or started production. Arrival, a UK electric vehicle manufacturer, listed on Nasdaq via a SPAC in March, projects its revenue to reach $14bn in 2024, despite not having produced any vehicles yet. “Not all, but most companies choosing the SPAC route weren’t ready or easily able to complete an IPO.
Either they were in businesses that had some issues (gambling, cannabis); or fascinating but unproven business models (OpenDoor); or products that aren’t ready for prime time (flying cars, self-driving cars, LiDar systems); or they just didn’t want to deal with the scrutiny that comes with an actual initial listing as opposed to a ‘back door’ merger to become public,” says Lise Buyer, a partner at the US-based IPO consultancy Class V Group who was involved in Google’s 2004 listing. “Most of the companies that have a strong business model and ‘clean’ story are still choosing an initial listing via a sale.” Some point to WeWork as a case point. The US commercial real estate company has gone on a slippery slope from a valuation of $47bn to near bankruptcy after its botched IPO in 2019. With the pandemic further hitting its bottom line, the firm has reportedly attempted to go public via a SPAC.
Some point to the recent history of the M&A industry as a cautionary tale for the market’s future prospects. Ivana Naumovska, an academic who teaches finance at INSEAD, draws parallels with reverse mergers, a trend that boomed in the previous decade but rapidly petered out in 2011 due to negative media attention and regulatory intervention. SPACs themselves faced a similar boom in 2007, ominously just before the Great Recession kicked off. However, few of them found target companies eager to go public. One of the clearing houses for SPAC companies was Lehman Brothers, the investment bank whose collapse sparked the financial crisis. But similarities stop there, says Milos Vulanovic, an expert on SPACs who teaches corporate finance at EDHEC Business School: “The financial crisis took liquidity out of the market, shutting down the offering of securities.”
A celebrity market
If there is one indication that SPACS may have bubbled out of control, it is the involvement of celebrities who are not usually associated with the financial sector. Celebrities promoting SPACs include Jennifer Lopez, Serena Williams, Shaquille O’Neal, Stephen Curry and Alex Rodriguez, with some even sitting on company boards.
Concerns over a SPAC bust that could jeopardise the fragile post-Covid recovery have alerted regulators
A sprinkle of glitter may be welcome to a market where digital native millennials are taking over and attention is becoming the ultimate commodity. “Sponsors are bringing in celebrities so that they can stand apart from the crowd. You can think of some of the celebrities as offering marketing services, just as in the advertising business,” Ritter says. “Celebrity involvement in SPACs is irrelevant to the market, because most of them are doing nothing but lending their names to an investment vehicle. Institutional investors pay little attention to it, or worse, they may discount a SPAC’s credibility,” says Don Duffy, President of ICR, a US communications firm that works with SPACs.
However, regulators think otherwise. In March, the SEC issued an ‘investor alert’ warning that celebrity promises for a quick buck should not be taken at face value. “Celebrities, like anyone else, can be lured into participating in a risky investment or may be better able to sustain the risk of loss. It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment,” the bulletin said.
Regulators on alert
Concerns over a SPAC bust that could jeopardise the fragile post-Covid recovery have alerted regulators. The SEC has warned target firms against offering misleading predictions and is currently scrutinising their accounting methods. In a statement that sent chills to the markets, John Coates, the SEC’s acting director of corporate finance, said that “Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.”
Ominously, he warned that de-SPACs should be subject to “the full panoply of federal securities law protections,” adding that “a de-SPAC transaction gives no one a free pass for material misstatements or omissions.” Some interpret this as a sign that the Commission may start treating SPAC mergers as IPOs, thus scrapping their legal protections. Many SPACs have exploited a loophole in US security law that protects companies going through a merger from lawsuits over overambitious forward-looking statements. Banks backing SPACs may also have to undertake the same liability risks that typically accompany an IPO.
In some cases, regulatory intervention has stopped SPACs in their tracks. One example is space transportation company Momentus, whose $1.2bn merger with Stable Road Acquisition Corp is under investigation over statements made about the deal. Other firms face shareholder lawsuits over allegations that their directors misled shareholders and investors. In the latest blow to the market, last spring the SEC forced SPACs to account warrants, which permit early investors to purchase shares at bargain prices, as liabilities rather than equity.
Many believe that the measure triggered the abrupt slowing down of the market in the spring. “Sponsor warrants are part of the compensation of the sponsors, and are a cost to the other stakeholders,” says Ritter. But others think that the market will slowly recover, unless regulators overreact and stifle the market: “Financially, it does not change much. For a $200m SPAC the cost would be a few $100,000s,” Vulanovic says, adding: “But it is an extra burden because many SPACS need to restate their financial statements. They need to contact the auditors and lawyers again and essentially go back in the queue.”
What worries regulators, and increasingly politicians, is SPAC-fuelled speculation that may hit retail investors. Critics argue that some SPACs have mastered the art of regulatory arbitrage, permitting fledgling start-ups to skip the rigorous due diligence process that comes along with an IPO; some have dubbed SPACs ‘Special Prevention of Accountable Control.’ “Paying attention to SPACs is justified, because there is a transfer of risk from venture capitalists and private equity investors to public market investors.
The rapid rise of SPACs has been met with a mix of bewilderment and excitement by investors and financial analysts
Many of them understand that risk, but some don’t,” says Denne from 451 Research, adding: “With a traditional IPO, the investment decision is based on the company’s historical performance. Most SPACs disclose some data on historical performance, but not in detail, so the investment is often about the future.”
However, others believe that the risk is minimal, given the idiosyncratic structure of SPACs. “In essence, a SPAC share is a convertible risk-free bond. Funds raised in the IPO are deposited in escrow accounts and kept there until the merger. There is no possibility that investors would lose any money,” Vulanovic says, adding: “The only people who risk any capital before the merger takes place are SPAC founders.” In some circles, SPACs are seen as the latest revolt against mainstream finance, coming on the heels of the GameStop saga that saw Reddit investors bet against hedge funds that were short-selling the US video game retailer.
Some think that SPACs offer to retail investors an opportunity to invest in small but fast-growing companies that were previously accessible only to bigger fish, notably venture capital firms. “I like to call a SPAC IPO a ‘democratised IPO’ because in a typical IPO the only people who get access to the shares are the investment bank’s clients, whereas anyone with a brokerage account can buy a SPAC’s shares in the open market,” says ICR’s Don Duffy.
Conquering the globe
Although the SPAC frenzy is largely a US phenomenon, it has already crossed the Atlantic. Prominent European investors, including ex-Credit Suisse CEO Tidjane Thiam, French telecoms billionaire Xavier Niel and luxury tycoon Bernard Arnault, have launched their own SPACs or are considering doing so. The trend has sparked competition among European financial hubs to attract SPAC listings, with Amsterdam leading the market so far.
Deutsche Börse expects up to 12 SPAC listings this year, according to an interview of Peter Fricke, an executive of the German exchange, to the financial newspaper Handelsblatt. In the UK, the Financial Conduct Authority (FCA) is considering implementing reforms that would make it easier for SPACs to list on the London Stock Exchange. Currently, restrictions such as suspension of trading following a SPAC merger hamper growth. But even some of the proposed reforms, such as setting a minimum of £200m to be raised when a SPAC goes public, may push many firms to list elsewhere, says D’Alvia from SPACs Consultancy.
The picture is similar in Asia, with regulators in Singapore and Hong Kong contemplating changes in regulation to attract home-grown SPACs. However, many Asian tech companies such as Grab have opted to list overseas via mergers with US-based SPACs. Such deals are symptomatic of the proliferation of fundraising options in regions that historically lacked access to global capital, Lazarow says: “As innovation models continue to scale internationally, and companies with strong future growth prospects seek capital beyond the limited options on established Asian Exchanges, SPACs will certainly be a key tool in the quiver.”
Two worlds coming together
The rapid rise of SPACs has been met with a mix of bewilderment and excitement by investors and financial analysts. Optimists see in this nascent market the first sparks of the forthcoming ‘roaring 20s’ that will follow two years of pandemic-driven doom and gloom. Others interpret the boom as a belated tie-up between Wall Street and Silicon Valley, hitherto seen as rivals due to the rise of fintech start-ups that threaten incumbent banks and financial services firms. Critics worry that the only string that holds together such a fragile marriage of convenience is greed, noting that the roaring 20s of the previous century ended with the biggest stock market crash in history.
Ironically, for some of the companies jumping on the SPAC bandwagon, their brightest moment may be the beginning of their downfall too. Regulators, policymakers and even the companies themselves should be worried about “the speed with which they made the leap from private to public, with much of the preparation and infrastructure-build required to be a listed company happening while public, as opposed to in anticipation of being public,” warns Lise Buyer.
“As one CEO said to me, it’s like standing in the town square naked and trying to put on your clothes, while dancing. Some will work out just fine and there will definitely be winners. But there will also be those that end up on the ‘don’t be this company’ posters.”