Special Purpose Acquisition Companies (SPACs) have been running rampant so far in 2020, with over $40.3 billion raised across a record 104 IPOs. Despite how easily these 'blank check' companies are able to turn private companies to public ones, investors should proceed with caution due to their track record of poor market performance.
What are SPACs?
Special Purpose Acquisition Companies, also known as SPACs and 'Blank Check' companies, are firms that have no commercial purpose whatsoever, and exist for the purpose of raising capital to acquire a private company. After acquisition, the company is usually listed on one of the major stock exchanges.
SPACs are often formed by investors or sponsors with some form of expertise in a given sector or industry. These vehicles turn the traditional IPO process upside down, as the SPAC holds an IPO to raise funds to acquire a company that has not yet been identified. After the IPO, the SPAC seeks to make a deal to acquire a company in that sector or industry. SPACs typically come with a two-year time-limit to acquire a company before the investments are returned to their shareholders.
The executives in the SPAC may have some idea of what companies they would like to target, but there can't be any negotiations or other work done on a deal until after the IPO to avoid having to disclose who the target is as part of the offering. This means investors in a SPAC IPO do not know what company they will be investing in. They are simply handing money to a management team and trusting them to find, acquire, and manage a company. This is why they are referred to as "blank-check" companies.
Glitter and Gold
The adage "everything that glitters is not gold" is important to keep in mind whenever considering investing in a SPAC. This is because the companies that have gone public through the SPAC IPO process have historically underperformed those that take a more traditional IPO path.
From 2015 through July 2020, there were 223 SPAC IPOs, with 89 of those completing their mergers and going public. Shares of those 89 have so far averaged a loss of 18.8%. Even worse than that, the median paints the picture of severe outliers, with the companies posting a median decline of 36.1% during that time. To put this in perspective, traditional IPOs rose by 37.2% over the same period.
What we can gather from this information above is that investing in a SPAC is much more speculative than an investment in a traditional IPO. The decreased transparency involved is a major driver of this underperformance as investors aren't given the chance to vote with their investment for which company they take public. Rather they invest and someone else picks the company they end up owning during the next two years.
This means that investors in SPACs must really believe in a certain industry, or the specific management team behind the SPAC. Since there was no company in mind, or at least not a stated one, there is no way to know if your investment at the end of it all went to management's Plan A, B, or Z. While every investor would be glad to invest in Plan B if a thorough evaluation found Plan A to be a bad business. Those same investors would be livid if they were told they ended up with Company B because Company A negotiated with them for 16 of 24 months and then told them no leaving management with very little time to negotiate a deal.
The SPAC process allows private companies to go public faster, and with fewer public disclosures and regulations than the traditional IPO process. This likely means that due diligence by investors is lower than in the traditional IPO process. An example of this could be Nikola (NKLA), which went public earlier this year through a SPAC IPO, and is now under investigation for fraud, including allegations that the company's semi-truck is not functional and was simply rolling down a hill in a video, despite then CEO Trevor Milton’s claims.
Recent SPAC IPOs:
Recent SPACs have outperformed the older ones in the study mentioned above with DraftKings (DNKG), Virgin Galactic (SPCE), and Nikola (NKLA) all undoubtedly skewing the averages higher this year. While it is uncertain how much can be attributed to each, recent success stories could be indicative of: better identification processes, more capable SPAC founders, and more trust in SPACs by the companies being acquired leading to fewer resorting to Plan Bs going public. It could also be that these companies are in incredibly hyped industries with few investment opportunities, leading investors to overvalue the shares.
For these reasons, among others, investors will want to thoroughly analyze SPACs and the company’s they merge with before investing.
Below is a short list of SPAC IPO stocks, some have already completed mergers, while others have either found their target or are still browsing the market:
Pershing Square Tontine Holdings (PSTH)
Whole Earth Brands (FREE)
Repay Holdings (RPAY)
DraftKings (DKNG)
Flying Eagle Acquisition (FEAC)
Nikola (NKLA)
Churchill Capital Corp. IV (CCIV)
Virgin Galactic (SPCE)
