What is a SPAC? That would be a special purpose acquisition company. A SPAC is essentially a fund working to take a firm public via a merger. About 250 SPACS were created in the U.S. in 2020 raising about $83 billion. An average of five per working day are being created this year. A SPAC might range in size from as small as $50 million, to as large as $4.5 billion, or the size of the one launched in July, 2020, by Bill Ackman, the manager of the Pershing Square hedge fund. The median size SPAC is about $240 million in its infancy.
Sponsorships: SPACS begin with a sponsor who uses his fund-raising skills and reputation to bring in capital for investment in a particular area or for a certain purpose. Some famous names from the world of sports, such as Shaquille O’Neal, Alex Rodriguez, and Colin Kaepernick have sponsored SPAC’s targeting socially conscious industries or sports-related companies. Private Equity is in the game, also, as well as hedge funds.
Some examples are:
Ack-SPAC: The largest SPAC on record launched by Bill Ackerman, the manager of the Pershing Square hedge fund.
SPAC-SPAC: A SPAC founded by Easterly Alternatives, and asset management firm, to invest in other SPACS.
Circular-SPAC: Sponsored by HPS, an investment firm, merges two private-credit funds, one of which owns a stake in the sponsor, HPS.
Shaq-SPAC: Shaquille O’Neal and Martin Luther King III launch a SPAC.
Sport-SPACS: Former baseball great Alex Rodriguez starts a SPAC intended to look for sports related opportunities.
SPAC Life Cycle: SPACS appear to have a life cycle of about two years, starting with the sponsor taking the firm public. As investors enter the SPAC, they generally pay about $10 per share. They typically receive warrants to buy future shares down the road. The sponsor then seeks out an acquisition target that is looking to raise capital to go public. When the target is identified, the SPAC shareholders vote to merge. If the merger is approved, the sponsor usually winds up on the target company’s board of directors and gets a piece of the merged company’s equity. The capital raised by the SPAC is then at the disposal of the target company, and the other SPAC investor shares become shares of the merged company.
As an example, in 2019, Chamath Palihapitiya, a boss of a SPAC, struck a deal with Sir Richard Branson, a billionaire businessman. Sir Richard was looking for capital for his space-venture company, Virgin Galactic. The proposal process was interrupted for a year, but when it resumed, the SPAC and Virgin Galactic merged. The venture capital raised was in excess of $674 million, and when it went public, its valuation rose to $2.2 billion. The merged company’s current market capitalization is about $12 billion.
How is a SPAC different from any other IPO?: The most important reason could be that the with the merger of the SPAC, the target company can foresee ahead of time how much capital it will have at its disposal. With an IPO, the offering price does not always translate directly into what the market will generate. The SPAC path is shorter and more solid than the traditional IPO path providing opportunities for companies in riskier industries, such as space travel, electric powered vehicles, and sports betting platforms. With SPACS there are also some cost savings.
What are the drawbacks to investing into a SPAC: Although some SPAC mergers, such as the Virgin Galactic example, are reaping huge profits for the sponsor and investors, others are not so successful. A recent study of SPACS by Michael Klausner and Emily Ruan of Stanford University along with Michael Ohlrogge of New York University discovered that between January, 2019, and June, 2020, the sponsor’s payout exceeded 12% of the post-merger equity along with a median stake of 7.7% in only a quarter of the cases studied. This, of course, would mean that three out of every four SPACS underperform those benchmarks.
Further, about 75% of the SPACS launched in the past year have yet to merge with a target partner. SPACS usually have provisions that allow investors to redeem their shares at their original cost until a target company is bought. This sets up an unforeseen risk to the sponsor who is targeting a capital supply to use to sell the deal to the merger target. This risk could press sponsors to act in a manner as to get a deal done with any willing company, and not work towards the ones that would benefit the SPAC and its investors best interests.
Which SPACS are most likely to succeed?: Like many opportunities in the world of business there is often a tremendous amount of hype involved with SPACS to lure investors into the fold. But questions arise as to how much the SPAC sponsor really knows about the business and industry the SPAC is merging into. Those SPACS with former Fortune 500 bosses as sponsors, or set up by private-equity firms, usually wind up outperforming the other rank and file SPACS. The manager is worth investigating for those who are seriously considering investing in a SPAC. Having a popular name for a sponsor might still mean that a former Fortune 500 boss is at or near the top working the controls. Even Shaquille O’Neal has teamed up with the former CEO of TikTok.
Conclusions: A SPAC, or special purpose acquisition company, is really a fund that’s looking for capital to buy or merge with another business, usually in a particular area or industry. SPACS differ from ordinary mutual funds in that they generally have a determinable life cycle that will turn the SPACS investors into shareholders of the acquisition target when a merger is complete. Before investing in any SPAC, I recommend that the investor inquire who is actually managing the money, and exactly what company the SPAC has agreed to merge with. With this information, most investors should be able to make a good decision about a SPAC investment both before and after the merger takes place. Another point to consider is the short life cycle of a SPAC, which ordinarily would require extensive monitoring on the part of the investor.
Sources: SPAC Invasion, The Economist, February 20th, 2021.
i don’t know… it all sounds a bit risky. and who has a few million dollars just sitting around looking for some action? and i wonder what Warren Buffett thinks of these investment vehicles.
You’re right in that they are risky. But their rise in popularity is meteoric.