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The amount of money raised by special purpose acquisition companies in the past year has soared.
SPACs are an alternative way for companies to go public that differs from a traditional initial public offering in its process, speed, disclosure and regulatory requirements.
Key participants involved in SPACs include SPAC sponsors and investors in the SPAC IPO. It also includes institutional funding, which often takes place when the SPAC merges with a private company to bring it public, and investors who own the new company for the long haul.
Here are some takeaways for investors to consider:
- There are large wealth transfers from some SPAC participants to others;
- The SPAC boom may bring more earlier stage, riskier companies to market; and
- While absolute returns for buy-and-hold SPAC investors have been high, this is less true when considering investment alternatives in a rising market.
There are many ways to get involved in SPACs with varying levels of expected returns. Here’s a look at the return analysis of completed and liquidated SPAC IPOs since January 2019, which covers 85 completed SPAC IPOs and five SPAC liquidations. SPAC participants were analyzed from returns on an absolute basis and relative to investment alternatives such as traditional IPOs.
- SPAC sponsor return estimates are imprecise given variation in terms, but appear to have been extremely high, given our estimate of their share allocations relative to upfront expenses, even after accounting for forfeitures, concessions and vesting provisions. The only probable way for sponsors to lose money is if post-merger share values fall below upfront costs, or when SPACs are liquidated with no merger.
- “SPAC Arb investors.” Before the merger, SPAC investors can redeem shares for cash if SPAC prices decline or sell in the secondary market if shares rise; they also receive warrants in the new company. A “SPAC Arb investor” is one that we assume exercises that option every time, cashing out of stock and warrant positions right before the merger. SPAC Arb returns have been very attractive, even for weaker deals given 100% redemption rights.
- Buy-and-hold investors are assumed to retain their positions after the merger and include upfront SPAC buyers, institutional investors funding at the time of the merger and post-merger buyers. Buy-and-hold absolute returns have been high (other than for the worst performers). However, in rallying markets, investors should always consider what they could have earned on other investments. Most companies brought public via SPACs have underperformed traditional IPO and Russell 2000 Growth benchmarks. This is particularly true when looking at deals with more than 180 days elapsed since the merger, after which private equity holders of the target company can sell their shares.
Dispersion of absolute and excess buy-and-hold returns is enormous. As a result, investors could end up with substantially higher or lower returns than median or average returns, depending on which SPACs they participated in. In principle, active management could add substantial value in this market.
Industry analysis highlighted the significant wealth transfers taking place with the SPAC ecosystem: from buy-and-hold investors to SPAC Arb investors, and from companies going public to SPAC Arb investors and sponsors.
Why might selling companies be providing these subsidies? The primary factor driving the SPAC boom may be speed to market rather than cost — most SPAC mergers since 2019 involve companies with negative free cash flow, although this is common in the traditional IPO market, as well.
Overall, SPACs have usually been terrific investments for sponsors unless mergers were not completed and SPACs were liquidated.
For SPAC Arb investors with low-risk optionality and free warrants, they are very compelling. For everyone else, there are good absolute returns so far but, in bull equity markets, rising tides lift all boats. Sponsor and SPAC Arb returns will likely not remain high indefinitely; experience suggests that they will eventually be reduced via lower subsidies, more vesting rules for sponsors and higher risk of deal failure.
The most interesting part to watch: How many of the 300-plus outstanding SPACs will be able to find a company to bring public at a reasonable price, avoid large SPAC redemptions at closing, lock in sufficient institutional backstop financing and complete a merger.
This pending universe is more than three times larger than the universe of completed mergers that we analyzed. As a result, the book on SPAC risks and returns for investors has not yet been completed.
— By Michael Cembalest, J.P. Morgan Asset Management’s chairman of investment strategy