Understanding SPACs Better

by | Opinions, Research

We inspect in detail how SPACs work, how has been the performance of SPACs in the past, and whether it is a fad that would fade away soon or meant to stay on.

SPACs are a major movement in the IPO world right now. Over the past few years, firms such as Nikola, Draft King, and Virgin Galactic have all joined the market through SPAC (Special Purpose Acquisition Companies). This has been a record year for SPACs with nearly $34.6 Billion in SPAC gross proceeds so far in 2020. That’s 3-4 times higher than the $12.1 Billion in gross proceeds in 2019 and the $9.7 Billion in 2018, as per Dealogic.

These structures, also known as blank check companies give private firms an alternative to an otherwise costly and time-consuming IPO process, making them hugely successful these days. Some investors see strong potential in SPACs and claim them to be a more effective way for firms to go public, but serious critics suggest they encourage backdoor transactions that are not worth the risk and promote opacity.

How do SPACs work?

SPAC mergers are very similar to a reverse merger. They are generally formed by investors with expertise in a particular industry or business sector to pursue deals in that area. While forming a SPAC, the founders sometimes have at least one acquisition target in mind, but they explicitly don’t identify that target to avoid disclosure requirements needed during IPOs. Hence, the name blank check companies. Many have argued that companies like Nikola and DraftKings wouldn’t have made been able to go through the normal IPO process because of the strict due diligence involved in a typical IPO.

Investors who buy stocks in the IPO have no idea what company they are ultimately going to invest in. They are effectively buying the target company’s IPO in advance (say Virgin Galactic) without knowing the essence of what the target company does and the price that will be paid by the acquiring company (say Social Capital Hedosophia Holdings Corp). It is important to note that these deals will be usually structured in such a way that if the investors don’t like the target company they can get their money back by just backing out of the deal before the merger closes.

Unlike normal belief, SPACs don’t seem to be cheaper than traditional IPOs. They pay underwriters and institutional investors a fee of around 5-6% of the sum raised and gives the founder up to 20% of the shares for free. Even after accounting for the additional cash brought in by SPAC’s sponsors and other friends and family, SPACs aren’t any less expensive than IPOs today.

With a conventional IPO, promoters and directors, and officers sign a lock-in for 180 days from the IPO date. For a SPAC IPO, the standard lock-in period ranges up to one year after the close of the closed merger or De-SPAC deal, subject to early termination of the common stock sell at a fixed price (generally $12 or above) for 20 out of 30 trading days beginning 150 days after the closure of the De-SPAC transaction.

The money earned by the SPAC is deposited into an interest-bearing trust account. The funds are only used to make an acquisition or to refund the capital to stakeholders when the SPAC is liquidated. SPACs normally have two years for getting completed or winding-up. Some instances include the SPAC’s working capital being funded by the interest received from the trust. Following the acquisition completion, a SPAC is listed on one of the prominent stock exchanges.

In our opinion, the fees and structure for SPACs would continue to whittle down and can become better than IPOs where bankers have created high-cost structures. Our primary concern is all-around compliance, investor rights’ protection, initial and ongoing disclosures, and scrutiny that make it safer for the general public to invest through an IPO. Unless SPACs can match IPOs in terms of transparency and reporting and third-party scrutiny (analysts industry experts), they will continue to be the domain of a small bunch of fund managers and institutions engaged in dodgy financial engineering. As the overall crypto industry has realized that being regulated has its benefits, SPACs will need to evolve to have the same or better standards than IPOs.

The biggest SPAC deals made thus far

Pershing Square Tontine made waves in the rapidly growing SPAC space with its July debut. The firm raised $4 Billion with its IPO, a record for such investment vehicles and a new sign of Wall Street’s obsession with SPACs. The stock is currently trading at a share price of $23.90.

Churchill Capital Corp III, and MultiPlan Inc. entered into an agreement to merge in a deal worth $11 Billion that will take the U.S. healthcare services firm public. The deal will expand MultiPlan’s data analytics platform and is the largest SPAC merger ever. The merged company will be listed on NYSE and will operate under the name MultiPlan.

MultiPlan will receive up to $3.7 Billion of new equity that will reduce the firm’s debt. The transaction includes $1.3 Billion worth of common stock at $10 a share and $1.3 Billion in convertible debt that will be convertible at $13 per share.

Blackstone-owned Vivint is also one of the biggest corporations to enter into a SPAC arrangement since the IPO. Blackstone had explored an IPO or sale of the technology company and ended up merging with a SPAC raised by SoftBank’s Fortress Investment Group, in a deal valued at $5.6 Billion including debt.

The SPAC and PE camaraderie

The SPAC burst is taking place at a time when trillions of dollars are sitting in private equity and venture capital funds. For institutional buyers, SPACs serve as an incentive to buy into glittering businesses that would otherwise stay private. Analysts claim that these cash shell structures remain a lousy gamble for average investors. The majority trades at less than $10-$12 per share, the regular price at which SPACs first sell their stock to the public.

For private equity funds, they have a strong economic interest in the company due to less upfront spending. A private equity fund financing a SPAC typically purchases between 2% and 3% of the shares on the public listing, more often by buying businesses via SPACs to pay down their obligations more efficiently.

For 21% of the founders of SPACs, an institution is either linked to a private equity fund or one of the managers is operating a private equity portfolio simultaneously.

Why are SPACs so popular now when they have been around since the 1980s?

In the 1980s, SPACs acquired a shady reputation tied to penny stock frauds. In the past two decades, new laws and regulations helped add credibility to bolster investor confidence. SPACs have an appeal to private companies that wish to go public in this volatile environment because SPACs guarantee the transaction at a certain valuation as opposed to the IPO which are seen as riskier and may or may not go through once documents are publicly filed. For example, WeWork’s IPO got scuttled once it published its details and intense scrutiny of the company led investors to back out.

  • It can take months for companies to negotiate pricing, file documents, get necessary approvals and then finally list on stock exchanges SPACs have an edge here where companies can work with stakeholders that understand them well and can conclude transactions quickly. Given the long timelines associated with an IPO, the valuation of the underlying company can also take a nosedive.
  • IPOs require significant private information to be made available to the general public for scrutiny. A large number of companies, especially tech companies are uncomfortable disclosing such details and may instead want to go through the SPAC structure which has lower disclosure requirements.
  • Businesses going public through SPACs in 2020 have had higher valuation and share price growth than traditional IPOs; in September, United Wholesale Mortgage went public in the latest SPAC transaction with a valuation of over $16 Billion.
  • With the quality of management teams improving, SPACs are gaining traction and more institutional investors and HNIs are buying in. With SPAC funds getting bigger, the scale of blank check deals is also expected to increase.

A lot needs to be done before SPACs go mainstream

  • One of the biggest issues is that firms going public via SPACs can afford to bypass critical oversight and intense scrutiny, unlike conventional IPOs. For example – Nikola, who went public via the SPAC a few months ago has turned out to be the focus on multiple allegations lately. Federal authorities have since begun to pose questions and the SEC is also investigating how SPACs report their ownership and how compensation is related to the purchase.
  • Investors are at greater risk compared to IPOs as they do not know the target investee company at the time of investment.
  • SPACs may prove to be quite expensive. In certain blank-check transactions, the founders of SPAC have the right to purchase 20% of the resulting public business at rock-bottom valuation. For example, initial shareholders of Social Capital got 20% of the Company at $0.002 per founder per share while the public shareholders got the remaining 80% at $10 per share.
  • Target firms also give up more power as they sell to a SPAC that has its operating staff in place. They are therefore subject to a vote and control by the owners of the SPAC. This can lead to deal cancelations even after the announcement.

Analyzing the performance of previous SPACs

We analyzed 50 SPAC merger deals that happened between 2015-2019 and how they are faring now. Are they profitable, what share price are they at now and how does the valuation look like? Look at the table attached in Annexure I for the detailed analysis.

While Nikola Corporation has been the biggest loser after its SPAC merger closed, its valuation has dropped by more than 50%, and currently stands at $7.14 Billion. The biggest gainers have been in the healthcare segment, financial services, analytics, and consumer goods. For Immunovant and AdaptHealth in the healthcare segment, the valuations have soared by more than 85%. For SaaS firms like Clarivate Plc, the valuation leap has been a colossal $5.7 Billion. Open Lending Corp which focuses on lending now has a share price of $26.12 with a valuation higher by 80% than its SPAC price.

The underlying fact is although some good names get benefitted from the SPAC route, total losses outnumber profitable SPACs. The majority of companies have not been able to perform well. Talking about the 50 deals that we analyzed, 37 of them (74% of total) now have current share price trading at less than $10 per share with a current average market capitalization of less than $250 Million. The number further disappoints as 40% of those firms end up with share prices trading at less than $5 in the stock market.

Upcoming SPACs

On 7th October, Momentus Inc. reported its intent to sign a merger agreement with Stable Road Acquisition Corp Momentus offers a “last mile delivery” service for spacecraft, with a transfer vehicle that helps deliver satellites from a rocket to a specific orbit. The merging business entity will be named Momentus Inc. after termination of the deal and its shares are to be listed under the ticker symbol “MNTS” on Nasdaq.

This merger will create the first publicly traded space infrastructure company. Strategic partners and clients include Lockheed Martin and veterans like SpaceX and NASA. The combined company will have an estimated valuation of approximately $1.2 Billion following transaction close in January 2021.

Post-merger Momentus will have approximately $310 Million in cash on the balance sheet, to be funded by Stable Road’s $172.5 Million of cash held in trust (assuming no redemptions) and $175 Million from a fully committed common stock PIPE at $10 per share, including investments from private equity growth investors, family offices and niche top-tier public institutional investors.

Will SPACs fare in the long run?

Bill Ackman’s SPAC which recently raised $4 Billion for his Pershing Square Tontine Holdings is by far the largest SPAC ever raised. There will be no founder’s stake in the company saving up on huge SPAC fees. If the SPAC succeeds in taking a large private company public – this will be the best proof of concept for the SPAC structure.

The premise of SPACs relies heavily on the reputation of the SPAC founder – their ability to raise funds from a broad group of shareholders. A blank check company is a testament to the faith that the investors have in that person’s ability to find and execute a good deal. We believe that the future of blank check companies remains doubtful. Investors find SPAC deals as a better way to go public, while critics argue that the SPAC boom is just a trend that isn’t destined to last in the long run.

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